Thursday, 22 December 2011

Joe Hockey's Gross Incompetence

From an economic perspective, I’m actually scared about the prospect of a Coalition government after 2013 with Joe Hockey as Treasurer. The unrelenting display of ignorance on basic economic and market issues should be enough to scare away international investors and undermine decades of great economic management.

Today’s article in The Australian from Mr Hockey is reproduced in full at the end of this post.

On the topic of gross government debt, I wrote this a few weeks ago - - as a primer for what will be an important plank in the longer run financial well-being of Australia – whomever is in government. Critical to the long run economic performance of Australia will be maintaining a deep and liquid market for bonds (Commonwealth Government Securities or CGS). This means that with the decision to maintain a stable level for the bond market (gross debt) as a percentage of GDP, gross debt will rise for ever in dollar terms.

This is the first obvious misunderstanding of a very basis principle from Mr Hockey.

Hockey is so perplexed by the issue that he says:

  • Gross debt continues to rise in every year of the forward estimates with no end in sight.”

Yes it will and that is a good thing. Mr Hockey, that is because the economy is getting bigger every year in the forward estimates with no end in sight.

No where does Mr Hockey mention the need for additional CGS as a global requirement from the new Basel III banking rules. Either he doen’t know about those rules or he willfully ignores them in an effort to make a cheap but illogical point. Either way, it is a sign of concern from the man who is the alternative Treasurer.

The Gillard Government successfully negotiated an exemption from the strict interpretation of the Basel III rules otherwise gross debt would have had to increase to more than half a trillion dollars! As it is, the amount of gross debt is tiny on any measure.

Mr Hockey, in other places, lauds the government for supporting banking competition by having the Australian Office of Financial Management (AOFM) buy Residential Mortgage Backed Securities (RMBS). This initiative involves the Government through the AOFM buying up to $20 billion of RBMS. In broad terms, these transactions add zero to net debt (the Government holds bonds issued by the smaller banks), but boosts gross debt by up to that $20 billion as it needs to raise money to buy them.

Mr Hockey again did not mention that some of the rise in gross debt is simply the result of prudent, sensible management of the economy and the nation’s finances through participation in the RMBS market, when that market failed during the GFC.

I wont rehash the other points about gross debt, other than to suggest Mr Hockey and others re-read my piece referred to above.

There is an obligation on The Australia or indeed Bloomberg, Reuters, Dow Jones, the AFR, Business Spectator or any other group with an interest in this issue to do a survey market economists, regulators and if possible the RBA and Treasury to get their take on Mr Hockey’s and the Coalition’s threat to block the rise in the gross debt ceiling.

I can’t preempt what they would find, but I’d be shocked if the findings weren’t a humiliation for Mr Hockey and his understanding of how to manage gross debt the Australian bond market. Blocking the legislation that allows for a rise in the government’s debt ceiling risks sparking a flight of capital from Australia (as we saw in the US earlier this year when Congress threatened to block the rise in the debt ceiling there) with consequences for the stock market, interest rates and the Australian dollar.


Our gross debt keeps growing

The Australian December 23, 2011 12:00AM

THE Gillard government is maxing out Australia's credit card much more quickly than it would have us believe and it's what it is not telling us that makes the situation even more serious.

The government is keeping major programs "off budget" so they have no impact on the underlying budget balance. These include $50 billion for the National Broadband Network and $10bn for the Clean Energy Finance Corporation, or "Gillard Bank".

The impact of these programs on overall government borrowing is shown in gross securities on issue. This is forecast to rise to a massive $272.4bn market value in June 2015.

Gross debt continues to rise in every year of the forward estimates with no end in sight. On top of this, the government has failed to explain how it plans to pay for several of its other commitments, such as its talk about a national dental scheme and the $6.5bn a year for a national disability insurance scheme. The Coalition fully supports doing whatever is possible to help people with a disability, but this spending has not been included in the projections of budget spending or debt. These additional commitments will substantially lift spending and debt.

There is now an increasing likelihood the government will need to again lift the legislated limit of $250bn on commonwealth securities on issue.

Although the Coalition has supported this in the past, the government should not expect a rubber stamp.

In a few years, Labor has increased its limit from $75bn to $200bn and, in May, to $250bn. Any proposal to lift the debt limit further should be assessed against five tough criteria.

First, all significant spending proposals must be subject to a cost-benefit analysis. It is shameful the $50bn government-owned monopoly NBN hasn't had a cost-benefit study, as recommended by the Productivity Commission.

Second, new spending proposals should be funded from savings in existing programs. Cancelling the carbon and mining taxes and associated expenditure would deliver substantial savings to the budget bottom line and would be a good place to start.

Third, the government must commit to a credible strategy for paying down debt across the medium term. Without further detail, the government's projection to reduce net debt to zero by 2020-21 is hardly believable, coming from a Treasurer who this year will chalk up his fourth huge deficit out of four budgets. It would require six consecutive annual reductions in net debt of $22bn. That is six consecutive surpluses larger in dollar terms than has been achieved previously (the largest underlying surplus was the $19.7bn achieved by the Coalition in 2007-08) or very solid growth in financial assets, which seems problematic given the likely continued financial and market volatility across the medium term.

Fourth, the government must publish key financial data for the medium to long term to enable proper scrutiny of its spending and debt. These should include total government expenditure, including spending for long-term projects that are presently classified "off budget", such as the NBN and Gillard Bank, and expected spending for proposals such as the NDIS. This additional information must also include securities on issue and gross government liabilities. This will provide for a more accurate picture of the spending undertaken by this government, particularly in those instances where much of this spending is to occur beyond the forward estimates and it will provide some assurance about the medium-term debt repayment strategy.

Finally, as I called for in my post-budget speech, the government should publish estimates of the structural budget position. A budget that is in structural balance across the cycle ensures surpluses in the good times to offset deficits in the tough times.

Unfortunately this government is running a deep structural budget deficit, with a $37bn headline deficit at a time of record high terms of trade and the labour market close to fully employed.

These are the criteria the government must address if it wishes to seek an increase in the $250bn debt limit.The lesson from Europe, Japan and the US is that countries must live within their means.

Joe Hockey is the shadow treasurer.


  1. How can you say gross debt is tiny other than in comparison to highly-indebted countries? A resource-rich country such as Australia during a massive resources boom should not have that level of debt. When the resources boom ends, we run the risk of both high government debt and entrenched high-spending.

  2. brianoh: What should be the level of government debt right now? What should the target for gross debt be for say, 2013? 2015 and 2020? What level for net debt? Cheers

  3. Stephen you don't fully explain the difference between gross and net debt, and one of the most important points Joe makes is in regards to off-budget spending which you don't mention at all.

    First of all, gross debt is often used as the best way to compare debt across countries because there are definitional issues about what gets included in the asset side of the net debt figures. For example, the Economist earlier this year published a chart of gross debt and had this to say:

    "The chart below shows OECD calculations of what it would take governments to reduce gross debt to 60% of GDP by 2026. This is around the level considered healthy and is also the ratio set by the widely ignored Maastricht agreement, which is meant to govern debt in the European Union. It is not pretty."

    That 60% figure is taken from Ken Rogoff and Carmen Reinhart's seminal work, This time is different. A book which solely relies on gross debt and finds that it has explanatory power. Do you disagree with the Economist and Harvard Univerisity Professor Ken Rogoff?

    In Australia, there are many issues with the government's net debt calculations. First of all, the figures include the non-equity investments of the Future Fund (around $60 billion) on the asset side but not the unfunded public servants super on the liabilities side.

    Second, the Commonwealth government often publishes charts comparing net debt across countries. Countries other than Australia have their sub-national debt included while Australia's doesn't. Go to p. 1-52 of the 2009-10 Budget for instance and there is not even a footnote to acknowledge this fact. Grossly misleading.

    Third, there is off-budget spending. One of the reasons that the gross debt continues to rise, even after surpluses return, is because the government is booking the NBN at cost and most of the Clean Energy Fund at cost. In reality, nobody beleives that either of these investments will be worth their costs.

    We already know from the McKinsey-KPMG work that the NBN will earn a rate of return below its cost of capital. If the government were a private company then fair value accounting rules mean that it would need to take a writedown on the NBN immediately. But then the government can do its books like Enron with impunity, no thanks to apologists such as yourself.

    I am not going to argue about Basel except to say it has nothing to do with what Joe wrote. The government's failure to keep below the $250 billion limit comes AFTER the Basel decisions. It is solely because we had a $15 billion blowout in this year's budget and a deteoration over the forward estimates, some of which is because of the carbon tax.



    The above is the Issuance Programme for:

    * Treasury Bonds
    * Treasury Indexed Bonds
    * Treasury Notes
    * Aussie Infrastructure Bonds

    "Treasury Bond issuance in 2011-12 (that is 1 July 2011 to 30 June 2012) is expected to be around $53 billion. After accounting for maturities of $14 billion this represents net issuance of $39 billion."

    What is the nett issuance to date from 1 July 2011 for Treasury Bonds?

    What is the nett issuance against the other sectors? What is the nett issuance for these other sectors from 1 July to date?