Saturday, 12 November 2011

Gross debt - gross ignorance

Admittedly, the notion of gross and net government debt is a little complex, but when someone speaks authoritatively about gross debt in particular, one would hope they understood the intricacies of the concepts involved and how the government debt market works before they opened their mouth. It is embarrassing and disturbing, therefore, to hear the Shadow Finance Minister Andrew Robb, join with the Leader of the Opposition in the Senate, Barnaby Joyce and Leader of the Opposition, Tony Abbott deliver sensational criticisms about the rise in gross debt in Australia.

The views of the Liberal and National Party leaders - the alternative government in other words - highlight a gross misunderstanding of markets, economics and conceptualising what is big and small.

Gross debt (which is predominantly the amount of Commonwealth Government Securities (CGS) on issue) rose as the Budget went into deficit due to the GFC. It is around $215 billion at the moment and is likely to rise to $240 billion in the next year or so. Whomever forms government, it is likely to rise to around $350 billion in the early 2020s.


CGS or government bonds are an integral part of Australian and global markets and liquidity (the ability to buy and sell them) is needed for smooth functioning markets. CGS is also needed to support trading in the futures market. In other words, the CGS market has to be big enough to allow financial market participants to operate without dislocating the market.

As Treasury made clear in the Budget in May:

"The Government consulted a panel of financial market participants and financial regulators on the future of the CGS market.

The panel underlined the crucial role of a liquid, AAA‑rated CGS market and associated futures market during the crisis and supported retaining liquidity in these markets as the primary objective for the CGS market in the future. The panel considered there was also significant value in maintaining a diversified investor base, including passive investors, to absorb any unexpected increase in issuance.

To maintain a liquid and efficient bond market that supports the three‑ and ten‑year futures market and the requirements of the new global bank liquidity standards, the panel agreed that the CGS market should be maintained around its current size — that is, around 12 to 14 per cent of GDP over time." (My emphasis.) See

Get it?

A liquid CGS market helped cushion Australia from the turmoil during the GFC. It allowed banks, financial institutions and other market participants to keep their doors open and continue to function in a reasonable fashion unlike the situation in the US, UK and parts of Europe when banks fell like ten pins. The bottom line is that the CGS market (gross debt), is an essential ingredient to the operation of Australia's financial markets

The amount or size of the market for government debt is clearly important. If you net off the government financial assets (as any business or even household would do), net government debt is a trivial 7% of GDP. That's the same as someone earning $100,000 a year having a mortgage of $20,000 with $13,000 in a savings account (net debt $7,000 or 7% of annual income) and net interest costs of around $600 a year or $50 a month. And no, I haven't "done a Barnaby" and left off a few zeros - these numbers illustrate the extent of Australia's debt "problem".

The recommendation from the panel mentioned above that gross debt be maintained around its current size as a percentage of GDP is a reason why gross debt will and should continue to rise. If nominal GDP grows at say, 5.5% per year, the amount of CGS on issue will need to double every 15 years or so. If gross debt is targetted as a dollar value, it will lose relevance as the economy grows over time. The common sense in having a target for gross debt that is equal to nominal GDP is because as the economy grows, its importance or relevancy to the size of the Australian economy remains constant.

Barnaby Joyce has indicated that the Coalition's target for gross debt is "to stop it increasing then reduce it". Financial markets and foreign investors in our economy should be unsettled by this promise. Either that or it is another one of the Coalition's blustering commitments that in government would be unworkable. If an Abbott government kept this commitment, it would see Australia's economic credibility undermined, capital flow out of Australia and our reputation damaged.

Australia's net debt is staggering low. Australia needs to issue bonds not because it needs to to fund reckless fiscal settings, but because the Gillard government wants Australia to remain an active participant in the global financial community. It needs the amount of bonds on issue to be linked to the size of the economy so there can be stability and some degree of certainty. It wont have these if gross debt levels are reduced.

PS: I haven't covered the Basel III matters which if adhered to in Australia would see gross debt exceed $500 billion. Well done to the Government for negotiating away from this nightmare.

PPS: In 2002, when I was working at TD Securities, I thought that Australia did not need a CGS market - see . Perhaps those views may have worked had the government at the time acted swiftly. It didn't and I was wrong for reasons linked to the dynamics of markets during the GFC.

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