There's sense in Hockey's taper caper

When Treasurer Joe Hockey and Treasury Secretary Martin Parkinson visited New York together in October, it wasn’t all chilli-dogs and rollerblading in Central Park. They found time for some pretty earnest discussions with Wall Street bankers.

As Martin knew, and Joe most likely discovered in a plush boardroom, the days of the Australian government having access to cheap debt were limited.

We are now at the beginning of the end of days, so to speak. In the post-Lehman era, every man and his dog wanted a few Australian Commonwealth Government Securities, meaning that until a few months ago, the Labor government could fund its deficits at a 10-year rate of around 3.4 per cent.

That’s not as cheap as US rates, but then Australia is not the home of the global reserve currency. We’re a good old fashioned casino, that’s all.

Today, the 10-year rate published by the Reserve Bank is around 4.1 per cent. That, as the bankers no doubt told Hockey and Parkinson, was set to jump higher when the Federal Reserve stopped printing money – the dreaded ‘tapering’ of its bond buying program.

The news yesterday that tapering would begin from January is welcome. It’s the beginning of a long climb back to financial normality – if there’s to be any ‘normal’ ever again, that is.

But what makes it such a long and difficult climb is that the central banks who followed the Fed’s lead in using the unconventional technique of quantitative easing to stimulate growth will be trying to sell those bonds back to the market. Bond prices will fall – that is, the yield payable will be much higher.

That trend will be amplified here. Australia’s role as a safe haven will end, and our government’s borrowing rates will sky-rocket.

What’s becoming clear is what this means for Hockey’s first budget in May. It helps explain some of the seemingly capricious things he did before Mid-Year Economic and Fiscal Outlook.

As many commentators noted earlier in the week, around half of the blow-out in this year’s deficit was due to things Hockey had signed off on, but in particular the $8.8 billion he handed to the Reserve Bank to recharge its foreign reserves.

This was widely interpreted as a trick to make ‘Labor’s last budget’ look as bad as possible, and to reap a large windfall for the government when the Australian dollar fell, pushing up the value of those reserves.

But there is another motive that becomes clearer by the day. Hockey wants to borrow as much as he possibly can while rates are low. Getting a heap of 10-year bonds away through the Australian Office of Financial Management is a priority. Once they are sold, the effective yield paid by the government doesn’t change.

And you can't borrow when you've got a spare $8.8 billion lying around.

Since the decision of Holden to pull out of South Australian and Victoria, premiers Jay Weatherill and Denis Napthine have been calling for all kinds of assistance, and were granted a $100 million package that Abbott said would "focus on our strengths, create jobs and exploit our competitive advantages".

But as everyone knows, one of our competitive disadvantages is the growing infrastructure spending deficit. Our road, rail, ports are groaning under the weight of economic activity.

As the mining construction boom comes off further, as Holden employees, retail workers and many more Australians lose their jobs, it is in the nation’s interest for Abbott and Hockey to borrow heavily and spend money on infrastructure. We simply must have those productivity boosts.

Abbott went into the election promising to be the “infrastructure prime minister”, though ruling out any spending on metropolitan rail. Since then, Premier Napthine has asked for rail funding to help soak up some of the workforce shed directly by Holden, or by the parts supply chain that supported it.

All of this points to a May budget with ‘harsh cuts’ in some areas, but a likely blow-out in infrastructure spending that will virtually ensure we don’t see a federal budget surplus for 10 years.

As most economists keeping point out, that really doesn’t matter at all. What matters is productivity and growth – not whether we’re carrying a small or small-to-medium balance on the nation’s credit card.

The $8.8 billion had to be swept into the RBA’s coffers to make room to borrow as much as possible before rates go up.

Despite all the rhetoric about “debt and deficit”, Hockey appears to be listening to the bankers and economists, borrowing cheaply to fix up the house we all live in before the rain comes.