- Joined
- 17 November 2010
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Money - it is not what you think
A comment from a reader:
"Govt deficit spending is funded by bond issuance. Large institutions and foreign entities are the primary buyers of such debt. The private savings rate does not have to mirror deficit spending "to the penny" since there are many other private savings vehicles not connected to govt debt issuance. However, govt deficit spending does divert capital out of the debt markets that would otherwise be available for business and other forms of productive lending."
I would have to strongly disagree with this point of view. Governments do not borrow first and then spend. Government spending does not divert capital out of the debt markets. Governments spend money first, with all their spending, to the penny, appearing as a deposit in someone's bank account. Simplistically, the Government is overdrawn in their Reserve Bank Account, and the banks, collectively are in surplus in their Reserve Bank account. The Government spending has created its own surplus, not diverting it from anywhere else.
The Government can just leave their RBA account overdrawn. Whether the RBA chooses to pay interest on the banks' surplus accounts is a question of maintaining a monetary policy, not a question of the Government being revenue constrained.
If the RBA/Government choose to pay a targeted interest rate (monetary policy) to the banks with surplus cash, the Government is in effect paying interest at a variable rate. That it chooses to extend the maturity of its "debt" from 1 day to 90 days (Treasury Notes), or 5 years (Bonds) etc, is a policy choice, not as a matter of necessity.
This fact is amply demonstrated by America's quantitative easing program. When the Federal Reserve buys US Government bonds it is simply crediting the sellers bank account with the proceeds of the purchase. It is only converting the debt maturity from, say 10 years, back to 1 day. Commercial Bank accounts will be in surplus by the amount of Federal Reserve purchases of bonds. The Federal Reserve's current policy is to pay .25% interest on overnight (1 day) balances. The banks already had about $1 trillion on deposit with the Federal Reserve, and that did not spark off inflation or increas bank lending. All QE does is to convert the maturity of the debt. To the extent that 10 year debt is more risky than 1 day debt, the Federal Reserve has reduced risky assets in the economy. Their hope is that investors will start to seek out more risky assets to achieve some yield.
Australian bank lending is not crowded out by Government borrowing. American banks have about $1 Trillion in reserves with the Federal Reserve, receiving only .25% interest. I think they would be happy to lend at a higher rate. The banks have not stopped lending, people have stopped borrowing. Borrowing comes first, not lending.
The Australian currency is a promise to pay. It is not backed by gold, commodities, or real estate or anything. The concept that Australia can run out of "promises to pay" does not make sense. The concept that Australia should run a budget surplus and accumulate its own "promises to pay" does not make sense. The concept that Australia has a Future Fund with accumulated $66 billion of "Australian promises to pay", invested with fund managers who are paid a fee, who in turn are invested in some form of risky assets, whilst at the same time borrowing $174.8 billion in "promises to pay" is also a strange concept. The Future Fund owns 1.09 billion of Telstra shares, whose share price has fallen $1 since 2009, being funded by 5.5% Government Bonds - strange indeed.
Government finances are simply not the same as Private finances. We are legally compelled to meet our obligations in "Australian promises to pay". The Government is only dealing with itself, so therefore, in reality, are not financially constrained. It is all a strange concept, but as long as mainstream thought treats Government finances the same as private finances we will all be burdened by policy dross.
Michael Cornips
A comment from a reader:
"Govt deficit spending is funded by bond issuance. Large institutions and foreign entities are the primary buyers of such debt. The private savings rate does not have to mirror deficit spending "to the penny" since there are many other private savings vehicles not connected to govt debt issuance. However, govt deficit spending does divert capital out of the debt markets that would otherwise be available for business and other forms of productive lending."
I would have to strongly disagree with this point of view. Governments do not borrow first and then spend. Government spending does not divert capital out of the debt markets. Governments spend money first, with all their spending, to the penny, appearing as a deposit in someone's bank account. Simplistically, the Government is overdrawn in their Reserve Bank Account, and the banks, collectively are in surplus in their Reserve Bank account. The Government spending has created its own surplus, not diverting it from anywhere else.
The Government can just leave their RBA account overdrawn. Whether the RBA chooses to pay interest on the banks' surplus accounts is a question of maintaining a monetary policy, not a question of the Government being revenue constrained.
If the RBA/Government choose to pay a targeted interest rate (monetary policy) to the banks with surplus cash, the Government is in effect paying interest at a variable rate. That it chooses to extend the maturity of its "debt" from 1 day to 90 days (Treasury Notes), or 5 years (Bonds) etc, is a policy choice, not as a matter of necessity.
This fact is amply demonstrated by America's quantitative easing program. When the Federal Reserve buys US Government bonds it is simply crediting the sellers bank account with the proceeds of the purchase. It is only converting the debt maturity from, say 10 years, back to 1 day. Commercial Bank accounts will be in surplus by the amount of Federal Reserve purchases of bonds. The Federal Reserve's current policy is to pay .25% interest on overnight (1 day) balances. The banks already had about $1 trillion on deposit with the Federal Reserve, and that did not spark off inflation or increas bank lending. All QE does is to convert the maturity of the debt. To the extent that 10 year debt is more risky than 1 day debt, the Federal Reserve has reduced risky assets in the economy. Their hope is that investors will start to seek out more risky assets to achieve some yield.
Australian bank lending is not crowded out by Government borrowing. American banks have about $1 Trillion in reserves with the Federal Reserve, receiving only .25% interest. I think they would be happy to lend at a higher rate. The banks have not stopped lending, people have stopped borrowing. Borrowing comes first, not lending.
The Australian currency is a promise to pay. It is not backed by gold, commodities, or real estate or anything. The concept that Australia can run out of "promises to pay" does not make sense. The concept that Australia should run a budget surplus and accumulate its own "promises to pay" does not make sense. The concept that Australia has a Future Fund with accumulated $66 billion of "Australian promises to pay", invested with fund managers who are paid a fee, who in turn are invested in some form of risky assets, whilst at the same time borrowing $174.8 billion in "promises to pay" is also a strange concept. The Future Fund owns 1.09 billion of Telstra shares, whose share price has fallen $1 since 2009, being funded by 5.5% Government Bonds - strange indeed.
Government finances are simply not the same as Private finances. We are legally compelled to meet our obligations in "Australian promises to pay". The Government is only dealing with itself, so therefore, in reality, are not financially constrained. It is all a strange concept, but as long as mainstream thought treats Government finances the same as private finances we will all be burdened by policy dross.
Michael Cornips
