The great debt furphy
Compared to the government debt held in other countries, Australia's debt is miniscule and shrinking. Debate about reducing it further is detracting from the real issues.
Net government debt in Australia reached a cyclical peak of 10 per cent of GDP in 2011-12 and the return to budget surplus will see debt fall to below 8 per cent of GDP by 2015-16.
Government debt is not an issue in the minds of anyone with a serious interest in the functioning of the Australian economy and its bond market. Australia has a triple-A credit rating from all three major credit rating agencies and government bond yields are near all time lows. The strength of the Australian dollar owes much to international investor confidence in public policy.
For the rest of the world, it is difficult to know for sure whether the level of government debt five or 10 times that of Australia’s is a problem or not.
At one level, it is easy to be very worried about sovereign debt levels when you see the US, UK and France with net government debt at 84 per cent of GDP and rising over the next few years. These levels are huge in absolute terms and certainly when compared to debt levels a decade ago when net government debt was 32 per cent of GDP in the UK, 37 per cent in the US and 53 per cent in France.
At the moment, Japan’s net debt is 135 per cent of GDP while in the so-called powerhouse of Europe, Germany, net government debt is a chunky 58 per cent of GDP.
Having noted those high levels, it is also easy to be relaxed about sovereign debt levels when almost all governments are having no difficulty funding their current budget obligations. Government bond yields in the bulk of the industrialised markets are near all time lows. In the US, UK, Japan, Germany, Canada and France the yield curve out to at least 10 years is at 2.5 per cent or less. Most short end bond yields in these countries are around 0.1 to 0.2 per cent and there are occasional spikes to negative yields in Germany. This highlights very clearly that governments are easily funding themselves, covering the budget deficit and all refinancing needs.
So why all the worry about net government debt?
The concern appears to be linked to the problems in Greece where net government debt is 170 per cent of GDP. The debt problems there are such that total recurrent expenditure would not even cover the annual interest bill if left unchecked. This clearly is when debt is too high.
This debt servicing fear is why Spain (debt is 79 per cent of GDP) and Italy (debt is 103 per cent) of GDP are being seen to have debt problems. The tax revenue base of these countries is so low that the markets are increasingly concerned that there may be difficulty meeting the debt servicing costs from the budget and at market determined bond yields.
In assessing the near record low government bond yields, it must be noted that bouts of quantitative easing and central banks setting interest rates between zero and 1 per cent are pushing bond yields to exceptionally low levels. Central bank intervention is also providing liquidity for funding these potentially massive levels of debt. In other words, it must be noted that many countries are having their budgets funded by their own central banks.
It is also the case that countries with large levels of foreign exchange reserves, most notably China, are also helping to cover government debt obligations with their holdings of bonds in their foreign exchange reserves.
It is by no means clear what actual level of government debt is a problem, nor what level is desirable. Suffice to say, it depends most simply on a government’s ability to meet the debt servicing costs.
What is clear is that the greater the level of debt, the greater the risk and vulnerability to shocks such as a rise in interest rates, a recession or an absence of funding. This is why Spain is seen as a massive risk with net debt at 79 per cent of GDP and the US has no difficulty with net debt at 84 per cent.
The lesson of the past decade is that when an economy is growing, it is best to pare back government debt levels. In a boom, pay back debt quickly. With softer growth do it slowly. This was the error of most governments made in the decade up to about 2007. There were good economic times yet rarely did we see budget surpluses.
For Australia, it is different. Net government debt has never been above 18.1 per cent in modern history and with it topping out at 10 per cent of GDP in the current cycle, any concerns about government debt are hopelessly misguided.
In 46 budgets between 1970-71 and 2015-16, there are 23 surpluses. Exactly half of the time, as a Keynesian would wish, there has been a deficit, half the time a surplus. Which just reinforces the point that there is no debt problem in Australia, no debt servicing issues, no interest rate burden on the government sector.
The debt level is chicken feed, it’s peanuts and it’s starting to fall from an already low level as the budget moves back to surplus.