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Nothing is at it seems

Who really understands the inner workings of our “modern vibrant” economy - that finely tuned mechanism that gives everyone a fair go and preserves our way of life? Turns out it’s more like one of those classic Bruce Petty cartoons with machines with lots of levers and belching fumes at the hapless operator.

I was recently surprised to happen upon a lecture given by a real life economist who managed to make the swirling mess make sense – and nothing is at it seems. I’ll try to explain- if you are prepared to accept the opinions of someone like me, who you don’t know and will probably never meet – but hey we do that every day when we swallow the opinions of News Corporation and Fairfax media empires, don’t we?

With charm and enthusiasm, Flinders University Professor of Economics Philip Lawn comprehensively dismantles all the old chestnuts used to justify government’s obsession with debt and deficit, their absolute belief in continued growth, and their lust for scaring the pants off everyone about pesky older people, dole bludgers, and I would add lately Middle Eastern death cults and those who dare ask questions on Q&A.

In explaining government spending, Prof. Lawn refers mainly to pensions, so, for the purposes of this article, which gives my summary of what Prof. Lawn is saying in the videos below, I’ll also refer mainly to pensions, although his explanations hold true for all forms of government spending.

Here's the gist of it:
There is no budget emergency. The Australian Federal government cannot go broke. Our taxes aren’t used to fund pensions, and government has access to as much $AUD as it likes, whenever it likes.

The Federal government has access to a bottomless pit of $AUD to finance the aged pension or indeed any of its spending. Although we are encouraged to believe that pensions, Medicare, hospital and school spending is bleeding us taxpayers dry, this is not true. We aren’t paying our taxes so that we can help fund our aged and disabled pensioner incomes, or build hospitals and schools. The truth is that taxes are levied on the private sector and working population to enable the government and other purchasers to spend in a manner that is not undesirably inflationary. Taxes are just a lever, used to quell inflation.
 
Prof. Lawn on Currency Issuing Central Governments and some macroeconomic facts:

Macroeconomic Facts

The Federal Government is a Currency Issuing Central Government (CICG) and is the monopoly owner and issuer of $AUD– which is a Fiat currency.

As a CICG, the Federal government does NOT have to tax, borrow or sell assets to finance its spending. Barring obstruction from a hostile Parliament, it has access to as much $AUD as it likes, whenever it likes.

You, I, State and Local governments, banks, businesses, are users of the $AUD. We do not have unlimited access to $AUD, and thus face day to day budget constraint. The Federal government does not. Its circumstances are not like that of a household, bank, businesses etc.

A deficit does not reduce government’s capacity to spend, nor does a surplus increase its capacity to spend. It taxes and sells government securities/bonds (described falsely as government borrowing) for specific purposes but NEVER to finance its spending.

A CICG NEEDS to destroy enough private sector spending power to nullify the inflationary effect of its own spending, so taxes are used to destroy private sector spending power.

Central banks – in our case the Reserve bank- sell government securities/bonds when a CICG operates a deficit in order to control interest rates.

So, CICGs spend first, then tax to the level required to nullify the inflationary effect of their own spending. Then, if required, government will sell government securities to maintain a targeted interest rate.

But- Can’t banks create $ out of nothing? ......Yes, but the money they create (financial asset) is always matched by a financial liability. However, when the Federal government creates $AUD for spending purposes it creates a financial asset but no offsetting financial liability.

Thus, the Federal government is the ONLY creator of net financial assets, which are needed for the private sector, in aggregate, to ‘net save’.

The important issues are:

- Will the real assets exist in the future for retirees (pension/super) to purchase?
- Will the basic G&S, health services, nursing homes, etc. be available for retirees to purchase with their income cheques?

And, as the population ages, and the working population shrinks, the nation’s ability to provide these real assets depends on:

- The productivity of the working population (economy’s sustainable productive capacity), and
- What proportion of the real stuff produced is made available in the form of real stuff needed and desired by retirees.

So you may be wondering, wouldn’t the Federal government’s exploitation of the bottomless pit lead to hyper-inflation a la Zimbabwe? (Called Demand–Pull inflation)

No it won’t........ well only if there is no competent management, because:

- Demand Pull Inflation occurs if net spending of the Federal government pushes Total (public and private sector) spending beyond the economy’s productive capacity (full employment level of GDP)
- If total spending is LESS than the productive capacity of the economy, there is no hyper- inflation, but there is unemployment. As has been the situation in Australia for the last 40 years!
- Ideally we want total spending to exactly equal productive capacity – full employment and minimal inflation, and there is NO REASON why the Federal government cannot manage its spending to ensure this is the case. It faces no financial constraints in doing so

This explains why the huge budget deficits of the US Federal government in 2008-2011 weren’t inflationary. Total spending in the US was still well short of the productive capacity of the economy, as proven by the official unemployment rate in the US at the time being 9-10%.

So in summary:

- A Currency Issuing Central Government can always net spend to a level that ensures total spending equals the full employment level of GDP
- It should never spend beyond this level as this would be inflationary. ....Only a fool would recommend this!
- If, once ensuring total spending equals the full employment level of GDP a CICG operates a budget deficit, so be it. It has access to the bottomless pit of $AUD. It can run deficits forever.
- Taxes paid by the working population do not finance the pension bill
- Taxes paid by working population are required merely to quell the inflationary effect of retirees spending and government spending.
- Federal government spending, including provision of the pension, is financed by creating new money and spending it into existence.
- The Federal government prevents this from being inflationary, and destabilising the economy by reducing the spending power of the working population by taxing it (i.e. it destroys some existing money)

What’s more, it is a furphy that if we get more people onto superannuation, they won’t be a drain on the poor old taxpayer, because:

- Taxes do not finance the pension. Pensions are financed by the Federal government creating new money.
- In order for retirees to spend in a way that is not inflationary, ‘spending room’ must be made available for them, by the Federal government taxing the working population. The working population still has to be taxed even if all retirees were financed by superannuation.
- If the switch to superannuation provides a higher fortnightly spending cheque for retirees, meaning they can purchase more Goods and Services, more spending room must be made available to prevent their spending becoming inflationary. .......
- Resulting in the Federal government having to tax working population more!

Are there other solutions?

- The Federal government could reduce its own spending – meaning fewer public goods and infrastructure – which Lawn believes we are witnessing now
- Increase the productivity of working population, negating the need for the Federal government to create more spending room, and negates the need to increase the tax impost on working population. By increasing productive capacity of working population:
- A smaller working population can produce same/more G&S for all citizens
- Overcomes the concerns about an ageing population
- Overcomes the need to increase tax impost on working population
- May even provide more G&S for retirees to purchase and enable the AFG to increase the pension  without having to increase taxes

What really matters is if there are enough real Goods & Services for retirees to purchase with their pension/super cheques. If not, retirees will be forced to compete in the market place with the working population for G&S – which will cause inflation.

Undesirable solutions include increasing tax on the working population or reducing government spending on provision of public goods. The desirable, sustainable, sensible, ethical, call it what you like, outcome is to increase the sustainable productive capacity of the economy (i.e. increase productivity of working population), thus ensuring a smaller working population can provide the real G&S to meet the desires and needs of everyone. Ah yes, I remember when we were told that one day we’d be able to enjoy shorter working weeks and retire younger!

That sounds good, so how do we increase the sustainable productive capacity of the economy? Well, we maintain our Natural capital; improve critical infrastructure - much of which has ‘public good’ characteristics so should be supplied by government; make technological advances –which requires R&D spending; and sustain the workforce - which requires spending on education, training, preventative health etc. This is starting to look like what most people want government to do isn’t it?

So, what is undermining our ability to achieve these things?

- High population growth rate
- Increased rate of resource use and waste generation caused by growth in real GDP
- Inadequate government spending on critical infrastructure, inadequate government spending on R&D, inadequate government spending on education, training, health etc.

Hey, Lawn has just described the government ideology – mind you there’s no resistance from Mr. Short One and his limp opposition. Both sides- the Laborials as Bob Brown once called them- are promoting population growth, promoting GDP growth (even though it no longer increases per capita well being) and cutting government spending!

Indeed, our high population growth rate means a larger proportion of economic activity must be dedicated to expanding infrastructure, equipment, skills etc. Each 1% growth per annum, requires 7-10% of GDP; however government infrastructure spending has been approx. 1.85% GDP per 1% growth per annum...... No wonder we can’t get a seat on the train!

And, how are we travelling at present?

- Labour productivity increasing at a low rate compared with pre GFC years (peaked around 1998-2002 – see Chart 3 Grattan Institute Report ‘Australia’s Productivity Challenge’ Page 14 here)
- Population growth and resources throughput growth is reducing the Natural capital that provides the natural resources needed in future
- The desire for GDP growth isn’t making us better off (GDP vs. GPI Genuine Progress Indicator)
- There is already inadequate spending on R&D, education, health
- Critical infrastructure has been run down due to inadequate government spending on public goods

The Federal government could run a balanced economy if only it wanted to – it just doesn’t want to. Instead it seems hell bent on stripping us down to our underpants and reducing our standard of living and quality of life. With indecent obsession, government is doing almost everything to undermine the ability of a future Australia to cater for the very challenging future we face, and is trying to repair an unbroken and unbreakable budget.

I just can’t get my head around the morals of these people with their hands on the levers of control. There is no budget emergency and the only black hole in Canberra is the bottomless pit of $AUD. We are being encouraged to begrudge spending on essential government services and those in need, misled that our taxes are funding that spending and to top that off a good dose of suspicion and fear towards our fellow citizens. Whoever is managing this climate of fear and suspicion has the morals of an alley cat.

If you’d prefer to hear Professor Lawn direct, without being filtered through my brain, I highly recommend his YouTube (Parts 1&2) which are embedded in this article. The URLs are: https://www.youtube.com/watch?v=-j-cqKQb1Ho and https://www.youtube.com/watch?v=et5Kt1NVwlQ

Jenny Warfe
July 2017

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Comments

Thanks Jenny,

That is a really good summary. Perhaps another way to think of it is to take out money, and just think about goods and services produced (as money as just a means of allocating these).

If the economy can produce x amount of food, y amount of infrastructure etc. Then what we as a society are faced with is how to allocate that production to various uses e.g a proportion for housing a proportion for new hospitals. It is not quite true that government spending is without limit, as the production of the economy is not without limit. So increasing the proportion for one must reduce the proportion for another - this is the fundamental choice of governments - although it is obscured under a cloud of noise about budgets, dole bludgers, the need to grow etc. The truth is the current population of Australia can produce plenty for people here, with some excess for those in need overseas who have already outgrown their resource base (thus need to import food, resources, etc from us). If we keep growing, soon that excess will be used entirely by our own population, or perhaps even we will not meet our own needs as environment degrades etc. So once the countries like Australia, America etc, have no spare resources to send overseas, countries like Europe, Asia and the middle east will start to starve, but that is not the perspective of the growthist lobby, who say we are not pulling our global weight unless we too destroy ourselves trying to share in the never-ending destruction of the planet.

Really the humanitarian thing to do is to not build over some of the last and best farm land in the world, but rather to preserve it feed those in less fertile areas - i.e that have already been destroyed by factories, pollution etc (i.e most Asian countries).

We are told to think globally, but we do not think globally in this sense. We bring people here when they will occupy and remove from production the very land that can, is, and will most likely feed them into the future? But we are told it is irresponsible and selfish to not 'share the global population burden' when in fact that is the most irresponsible and short-sighted thing to do.

Why are not the Greens and other environmentalists making this case?

Just to add the above, the point raised that the economy produces a certain amount of good and services and governments determine or influence how those are directed to different areas highlights the fundamental problem and lie with the superannuation system (which Jenny raises in relation to pensions).

Either superannuation or the pension can be used to direct resources to retirees (i.e housing, food, medical care, etc). The pension system does this equally for everyone - thus someone who worked in a low paying job (like a cleaner, nurse, teacher etc) gets the same care as a CEO. Superannuation though is about how much individuals have put aside personally - thus the 'cake' is not evenly shared - richer individuals will be able to get more, simply because they had higher paying jobs, poorer people, and those less able to manipulate themselves into high paying positions consequently risk not being well looked after under a superannuation regime. I personally have many other criticism of superannuation eg: forcing everyone into ponzi stocks or housing investments, the transfer of wages from individual control to semi-government control (super payments reduce wages and then feed a massive, expensive, useless and unnecessary system of fund managers, accountants, auditors etc - all sucking productive capacity which could be used to produce more real goods and services). I could go on!