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Government debt, inflation and interest rates.

August 5th, 2009 · Greg Atkinson · 15 Comments

The tentative signs of a global recovery (albeit a weak one) are becoming stronger each day and people who predicted a global depression have faded from view.  So the Australian economy is poised for growth again and everything is back on track right? Well not quite.

As a result of the global financial crisis a number of governments around the world decided to embrace Keynesian economic theory (well the bits they liked that is) and have racked up huge amounts of debt so they could shore up their voter support, oops I meant help their economies.

In Australia the Rudd Government has been spraying around money via a number of somewhat questionable economic stimulus measures and these have plunged the nation into debt. As a result we will all have to chip in and pay back the few hundred billion the country will end up borrowing.

Many Australians may have appreciated the pre-Christmas Government cash handout but the truth is that this money and more will be clawed back over the years to come. In fact not only will taxpayers be giving back the cash handout, they will also be paying for a whole range of Government spending splurges in addition to making interest payments on the money Rudd and Co. have borrowed so they could make grandiose promises. (see: Rudd Economics 101 – When in doubt spend like crazy.

Therefore what we can safely say is that in the coming years the Federal Government will be looking to bring in extra dollars to pay down debt and also to fund billions in extra spending commitments. Without a doubt the National Broadband Network (NBN) will run over schedule and over budget, the reform of the healthcare system will become a budget black hole and the so called “Education Revolution” will suck up money while not providing any tangible results. (children will not become smarter because they have a new school hall)

But then we have the State Governments most of which has mismanaged their economies and are also in debt. In many cases State Government charges are already on the way up and you can be sure more increases are coming.

As all levels of government start to claw back money this will start to give inflation a nudge as everything from public transport fares to public health care costs will start to rise. In addition if the Emission Trading Scheme (ETS) becomes a reality then businesses will be hit with an extra tax and the consumer will end up paying for this via higher prices for a whole range of good and services. Into the mix add a higher oil price and the end result is likely to be inflation moving out of the Reserve Bank’s comfort zone.

The RBA has signalled that it is no longer inclined to cut rates further and in essence this means the RBA is moving into a position to keep inflation under control. So I guess the RBA also sees inflationary pressures building, but what does this mean for the Australian economy?

The main problem I see on the horizon is that unemployment is likely to still be creeping up at the same time that the Government and RBA will need to deal with rising inflation. The global recovery might slowly be taking hold but this does not mean new jobs will be created in Australia or that positions shed during the downturn will be reinstated.

The unpopular truth is that the roll-back of Work Choices has made the Australian labour market less flexible and less able to deal with an extended economic downturn. In fact the labour market in Japan is dealing better with a much more severe recession than Australia is even though Japanese exports have collapsed. Unemployment in Japan is still lower than Australia which has had the benefit of it’s exports holding up relatively well.

Unemployment Rates: Australia, United States, U.K. and Japan (Jun 09)


It is likely that Australian businesses will remain cautious for at least the 6 months and that further jobs will actually be lost. If the ETS legislation is passed the situation will probably be made even worse as companies look to move operations offshore to countries like India or China rather that expose themselves further to the ETS tax. (let’s call a spade a spade, the ETS is a tax)

So the most likely scenario I see at the moment is one where the Australian economy remains fairly weak and yet inflation rises. Jobs are unlikely to be created in any large numbers in the mining sector for quite some time and the ETS is hardly going to encourage businesses to put on new staff when they are uncertain of how this legislation will impact their bottom line.

The end of the extra handout to first home buyers will probably cause prices to soften a little in the housing market up to the $400-500K level but I do not see too many major property developers rushing to build new homes so supply side restraints should provide some support for home prices for a while.

The big unknowns are where the price of oil will go ( I am confident however that we will soon see oil over $80 a barrel soon) and how aggressively the RBA will raise interest rates. Things could get nasty if both of these rise quickly and we may find Australia lagging much of the world out of the global recession.

The recession in Australia is not over yet.

15 responses so far ↓

  • 1 Ned S // Aug 5, 2009 at 2:06 pm

    G’day Greg – That’s a pretty accurate assessment for mine. As to asset prices generally, expect them to hold up due to inflation and the pressures of investors chasing gains.

    Speaking broadly, the GFC has been a heck of a learning experience for me. A few big points have come through:

    Banks are pivotal and they make money from lending and they do it by leveraging deposits.

    Savers will always get creamed, but most especially in a situation like we’ve seen recently where existing debt has to be propped up and more debt encouraged – Basic mathematics (in a capitalist democracy with debt funded growth) – If dropping the interest rate by 1% takes $100 off a saver who has $10,000 in the bank it puts $100 in the pockets of each of the 10 borrowers the banks lent that same $10,000 to 10 times using leverage – So take $100 off a saver and pump 10 * $100 into the economy. That’s a real good deal – Except for the saver – Smile!

    Asset price inflation has to be supported to keep borrowers borrowing or the system will cease to function. (The banks pay taxes on profits; the borrowers spend money and taxes get paid on the money that is spent – Yep, governments are going to keep that system functioning.)

    Why do the RBA “fight” inflation? (As in try to keep core inflation around maybe 5% pa) Don’t want to kill the goose that laid the golden egg – wipe out savers with inflation too quickly and obviously they’ll stop saving so the banks will have no deposits to lend out on leverage to borrowers.

    So the the RBA says one thing but encourages another – Stevens is full of horse manure with his rabbiting on about the “next” business cycle being different and based on lots of conscientious saving and subdued asset price inflation – They’d wet their panties if they thought that really might happen and drive interest rates to 0% and print money so quick we wouldn’t have time to blink.

    How could the Yanks get something so easy so wrong? Well lots of ways actually – They spend WAY too much compared to what they produce; They let poor people borrow money and got the risk assessment wrong but figured lots of it was offloaded anyway – Not so apparently?; And they can’t bear any pain (or the thought of working competively for a living in a globalised world) so they insist on real low interest rates at home to give them lots of easy money to spend and invest; Plus as the holders of the global currency they got bloasted with petrodollars and Asian savings; And they reckoned they were invulnerable (for a few other reasons as well); And their regulators dozed off for a decade. There were probably a few other contributing factors, but those few in themselves would have probably been enough to give them some grief – Smile.

    Stocks – It’s easier for the smarties to remove money from the patsies than with housing. Even America is only down 20% on its housing. So stay out of stocks unless one is a smarty.

    What will happen when the boomers fade out of the game? Some pretty nasty changes maybe. But until then, the game goes on. With high taxes to pay off the current stimulus and maybe some regulatory changes to moderate the game a bit. But the basic game remains the same – Banks, leverage, debt, inflation, asset price growth, taxes, government and democracy.

  • 2 Ned S // Aug 5, 2009 at 3:17 pm

    Couple of other real general comments:

    I seems to me that we’ve seen the start of a major move away from considering Aussies who put extra money into super as responsible citizens seeking to ensure they are not a burden on the pension system to wealthy freeloaders who are trying to get out of paying their fair share of tax.

    Property ownership is a political issue. I’m half expecting tax laws to change in relation to it. We could see Ken Henry coming out with stuff that will favour investing in the development of new housing that is sold while penalising the holding of significant portfolios of rental property.

    We are creating a practically difficult and dangerous financial world for the oldies with superannuation and retirement – Who exactly could be comfortable letting the prats who run the super funds manage their investments? But who really wants to be managing their own at the age of 80?

  • 3 Greg Atkinson // Aug 5, 2009 at 5:06 pm

    Ned S I do have a giggle when I hear Glen Stevens talk about how things will be managed better in the future. This is from the guy who never saw the global economic crisis in the first place and hiked interest rates too far! Regulators and politicians always ramble on about how they will fix things in the future but as sure as night follows day they will create further problems.

    The Ken Henry review worries me a lot. The chances that a bunch of bureaucrats will come up with anything but a money grab is pretty remote. It is a real concern that this review is taking place at a time when the government needs to put a hand into our pockets. I would guess that people who have saved well and acquired assets through hard work will find themselves as part of some Ruddish wealth distribution experiment!

    We are slowly creating a society where people simply expect that a house, a car and money to spend are their rights and that having to make sacrifices to get ahead is unfair. What is worse is that both side of politics pander to this view and we are wasting the bounty from our resources exports on short term handouts.

  • 4 Ned S // Aug 5, 2009 at 6:52 pm

    I only disagree with you on one point Greg – Namely that the RBA raised the interest rate too high. Although all the debtors in society become mortally offended at the thought that any interest rate above 0% could possibly be desirable.

    But the RBA had no mandate or tools to fight bubbles. And that American dill Greenspan did the Pontius Pilate routine on the whole concept anyway. So the RBA was always pushing loose runny stuff uphill with a garden rake. But they tried. And (along with ASIC) seem to have done very well compared to the likes of most. But having said that, I also accept that the RBA were totally clueless regardless seeing the GFC coming.

    Still, it is amusing that the country that had the highest interest rates for longest is holding up best. The minerals are our REAL saving grace of course! But hey, being favoured by fortune isn’t a crime – Heck, the Asians work hard. And the Arabs have oil. And America holds the global reserve currency – Most countries that are anything have something going for them. (Never did figure out the UK – Maybe that’s why they have to go back to the US or the IMF every 30 years with the begging bowl extended?)

    But showing any tendancy to become reliant on fortune “tempts the gods” perhaps? (Smile!) So Yes, it’s time Oz started thinking in terms of how to be smart (and/or hard working!) as well as just lucky. Doubt we will though.

    Ken Henry … Potential for significant societal change in all of that. Me? I’ve considered bailing to the US because I figure they’ll always be way more capitalist than us. But reckon I’d squabble with Yanks too much – Their mental image of what a blessing their nation is to the world and mine don’t quite line up. Curiously enough that evil ex-communist “abomination” called Russia is shaping up to be my bolt hole if push should come to shove re my retirement. Monopolistic, grossly capitalist – But not in the “Let’s destroy the world way the Yanks are good for”; lots of issues … Including high inflation. But they value personal freedoms a real lot and don’t pretend to be saints that they aren’t. A bit laze faire even? Heck, I just genuinely like the people – Way more than Aussies or Yanks or others. Sensible, practical, no big expectations, accepting that their system is corrupt and happy to work with and within that rather than bleating about how things really should be different when their own particular corrupt spiv deals don’t work out. Not too bad at all for mine.

  • 5 Greg Atkinson // Aug 5, 2009 at 8:14 pm

    Yes Ned Oz seems to be doing fairly well thanks largely to commodities but who are we to complain? 🙂 I do still feel however that the RBA raised rates too far so we will have to disagree on that point 😉

    Regarding relocation, 8020 Financial who frequently pops in here highly recommends Estonia. Personally I will sit it out a while in sunny Japan.

    As for fighting bubbles I think it is a bit of a lost cause. Even if the RBA had a mandate to do something they would have no control over government policies and as we know from the sub-prime mess, governments create many of the problems that help form economic bubbles in the first place.

  • 6 Ned S // Aug 6, 2009 at 9:28 am

    “Even if the RBA had a mandate to do something they would have no control over government policies” – Too true Greg – Back to Macfarlane’s point about democracy and economic stability not being compatible I guess?

    I see Ms Clinton is prattling on about the untold financial benefits of democracy to the Africans. While China is busy investing there. Correct me if I’m wrong but China isn’t a democracy is it? Yet Hillary’s mob are in real deep hock to them. Wonder if the thought ever crossed Hillary’s mind that some people just might see a possible contradiction there?

  • 7 Greg Atkinson // Aug 6, 2009 at 3:04 pm

    Ned I reckon Macfarlane is right. But then again who would want to live in a world ruled by economists!?!

    Yes I often wonder if the U.S. sees a conflict between rattling on about human rights but happily borrowing from a communist nation with not a great track record in that department.

  • 8 Ned S // Aug 7, 2009 at 9:02 am

    Greg – Re your comment elsewhere that Asia is more than just China – Agreed certainly. And it’s a good thing too. As I’ve learned more about what makes the world tick, I’ve been appalled to realise the level of risk Oz is exposed to through it’s dependance on minerals. And we certainly don’t need to be exacerbating that by having only one customer. This is just an extremely risky little country to have all of one’s assets invested in long term. Of course the other argument is “When you are on a good thing, stick to it”.

    But the thing that I find fascinating (and potentially so different) about China is that through not being a democracy, they have controls over their economy in ways that others very obviously do not. And an ability to respond very quickly. I know nothing about the mindset of the people but get the impression that they are actually quite happy with the existing arrangement – So much for fears about “riots in the street”. And the whole arrangement seems to be very good for Oz.

    “Communist Capitalism” – Who would have thought that would stand up well in comparison to “Democratic Capitalism” – But it is logical enough I suppose – Here are the good bits of capitalism – You will embrace them; These are the bad bits of capitalism – Embrace them and you get a bullet!

    Any idea that Oz would be OK because “China” had decoupled significantly from the US is obviously false. But one has to expect significant decoupling to be actively encouraged over time now. Again, not a bad thing for Oz at all regarding reducing risk. And in many ways it is just possible that emerging Asia could benefit from more cost conscious and somewhat spendthrift American consumers continuing to pile into Walmart longer term anyway – Which again is still good for Oz.

    But we have our own internal issues. With housing being the real big one – It is all anyone here really seems to care about in relation to the RBA and interest rates. Glenn Stevens comment about the desirability of ensuring more housing gets built rather than just more expensive housing, lined up too nicely with a bunch of my previous thoughts on housing to not just reaffirm that the Ken Henry tax review is the obvious place to tax advantage some forms of investment and tax disadvantage others to ensure that Glenn Stevens preferred outcome results.

  • 9 Senator13 // Aug 7, 2009 at 9:29 pm

    With the recent announcements from the RBA and positive data coming out, is it necessary for the Government to go through with the remainder of its stimulus payments?

  • 10 Greg Atkinson // Aug 8, 2009 at 9:08 am

    Ned S – I think the danger is that we as a nation focus too much on China and not have a Plan B as I have mentioned before. Why is it for example that Japan can make steel with our iron ore and coking coal and export in back to Australia? How did we manage not to become one of the top steel producers? As a maritime nation why are so many of our ships build overseas? The list is almost endless.

    Our economy is doing well so far not because our economy is better than others, but because we have a small export focused manufacturing sector and China is propping us up.

    China is spending like crazy not because they embrace capitalism as such but because the people in power want to stay in power. (just like in Australia!) When Chinese exports fell the central government had two choices: allow millions of ex-factory workers to sit around thinking about why they have no job or, get these people busy building roads, bridges etc. Clearly they went with the second option.

    The questions are: how long can China keep pumping money into infrastructure projects before it starts to hurt and what will happen if Chinese exports never fully recover?

  • 11 Greg Atkinson // Aug 9, 2009 at 10:16 am

    Senator I think the quick answer is no but I fear Rudd and Co. like the attention they get from making big promises and spending our money.

  • 12 Senator13 // Aug 9, 2009 at 11:44 am

    I’m happy to be corrected if I am wrong or am missing something. But, I would have thought that now would be a good time to remove the banking deposits guarantee too. I am no expert in credit markets, but I would have thought that by removing the guarantee or at least scaling it back it would send a confidence single to the market and would help ‘get the juices flowing’ as they say back in the credit market. So between looking at that and some scaling back of the stimulus payments I think it could send some signals of confidence back into our economy.

    As I have said I am for the road, rail and ports side of the stimulus spending, but there are billions of dollars of other unnecessary spending where it might be better to hold off on further spending. Every cent saved is one more that we don’t have to repay and can save on interest payments later down the track. It might sound simple but down the track that interest bill is going to be a killer and really hold things back because it will be a big drain on every single budget from here on in.

    Surly we now have enough Julia Gillard Memorial School Halls?

  • 13 Greg Atkinson // Aug 10, 2009 at 7:55 pm

    Senator13 I agree with you. We need to appreciate that the massive amounts of money being pumped into Chinese infrastructure projects has dome more for our economy than the measures taken in Oz. So now seems a good time to ease back on Government spending especially since we know the RBA is moving into inflation fighting mode.

  • 14 Greg Atkinson // Feb 25, 2010 at 8:44 am

    Interesting article from Barnaby Joyce about Australian debt today in The Australian.

    I have been going on about reckless spending and mounting debt for quite a while so I am happy to see someone else is worried about this as well. We all should be!

  • 15 Senator13 // Feb 25, 2010 at 10:46 am

    I thought this was a good article and highlights some pretty important points.
    I hate how the Govts only defence to the state of debt is that everyone else is worse.

    Perhaps a better analogy regarding our debt would be driving and getting pulled over for drink driving and being over the limit but claiming its not bad as the person in front of you was over the limit by more.. Either way you are over the limit. And either way our debt position is not good.

    It is time these points were brought up more as we are talking some huge figures.

    If the best Swan and Tanner can come up with is that Joyce is crazy and use tong slips to attack him then we are in real big trouble.

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