It has been a busy week at the Glass Pyramid as a cloud of confusing and obfuscating commentary on “Foreign Debt” has again descended on the nation.
Never have so few worked so hard to convince the general public that racking up trillions of dollars of debt to foreign lenders is nothing to be worried about.
The objective of the exercise seems clear … sprout enough economic gibberish in a condescending tone and hopefully the populace will relax and go back to regular programming …. another plate of unproductive capital inflows (foreign debt), another serve of imported goods / services, more job losses, more businesses heading offshore and all with a side serve of smashed avocado (though only if Bernard Salt has approved your demographic to munch on the stuff).
So what did Ross do ?
He is normally such a pleasant avuncular chap and often says unkind words about the current government’s state of economic confusion, so surely he is one of the good guys / aka one of the few remaining ‘progressives’ at Fairfax not engaged in marketing the glorious housing bubble and the remaining trickles of gold ?
Well a lot of the time he does say sensible stuff but every so often he reaches into the bag of economic fables and myths and pulls out a big hairy rabbit with a bad case of myxo.
Yesterday was one of those days.
The key to spotting nonsense in any article about Foreign Debt is to look for the words productive and unproductive.
If you cannot see either of them you can be quite sure that what you are about to read is a bunch of half baked hokum cooked up in the spruik laboratories of neoliberalism international incorporated.
See the key to having any sort of sensible understanding of Foreign Debt, or any type of debt for that matter, is to distinguish between productive and unproductive applications of the debt.
In simple terms debt that is applied to the expansion of the productive capacity of the economy is broadly ok – though please note that broadly ok is a world away from rapt endorsement.
However, debt that is not applied to the expansion of the productive capacity of the economy is not okay. It is unproductive and does nothing but slow burning economic harm about which banana republic inhabitants sing sad songs around the campfire.
Applying the above simple tests to the question of foreign debt the question then becomes
“How much of our $1 trillion in public and private foreign debt was incurred for productive v unproductive purposes”
So what did Mr Gittins have to say about this?
Ross just imagines the issue away with a wave of his hand.
Accordingly to Ross all that Foreign Debt / Foreign capital flowing into Australia is helping us develop our economy faster and we could not survive without it.
What complete and utter bullshit.
Ross’s technique in the article is tried and tested. Foreign Debt spruikers and apologists simply call all foreign capital inflows ‘investment’ because that makes them sound like they may be ‘productive’ and it means that now they don’t have to deal with the fact that most of the foreign capital inflows they are praising are nothing like ‘investment’ and for the most part are completely unproductive or speculative.
Most of that $1 trillion of foreign capital was not flowing in to expand our productive capacity at all. The vast majority flowed and continues to flow in for the following very very unproductive purposes:
- To purchase bonds and other IOUs issued by our banking sector so they can supply record low mortgage interest rates to speculators and others so they can, for the most part, bid up and bet on the prices of the existing stock of residential land and housing. While recently there has been more new housing construction (and that is a productive expansion of the economy) the majority of mortgage lending is secured by the existing and often decrepit housing stock). Foreign debt is goosing our house prices and Mr Morrison implicitly endorses it by doing nothing to stop it.
- To merely acquire title to already existing assets. When a foreigner buys title to an existing asset there is no expansion of the productive capacity of the economy. There is nothing more than an unproductive capital inflow and an outflow of a title to an asset. Mr Andrew Robb and Ms Penny Wong fought long and hard to win the title of who would allow foreigners to acquire more title to Australian assets the fastest. Mr Robb and his young dark Jedi Steven Ciobo remain slightly ahead in that sad race.
- To acquire title to securities issued by the Federal Government for the purposes of financing recurrent government expenditure (just a fancy way of saying blowing the dough on day to day expenses rather than expanding the productive capacity of the economy). As Mr Gittins noted from the recent speech of Guy Debelle – 60% of all bonds issued by the Federal Government are held by foreigners. Just ask Mr Morrison what that money was spent on and he will unhappily tell you that in his opinion much was spent on leaners and grifters (i.e. low income earners). In fact “The Australian” only this week editorialised on the amount of foreign debt incurred for spending on fripperies like social security etc. See this link for the Glass Pyramid dissection of that. While the Glass Pyramid does not agree with Mr Morrison’s or The Australian’s characterisations, borrowing from foreigners for recurrent expenditure is a mugs game.
So how much of that $1 trillion dollars has been invested in the productive expansion of the Australian economy and how much has been sunk into speculation on asset prices (house price bubbles), mere acquisition of title to Australian assets and buying up the bonds of the Federal Government to fund day to day living expenses?
Start counting Ross and if you come up for air before noting $700-$900 billion sunk into unproductive applications of foreign capital you might be doing very well.
In one of the weirdest lines in the article Ross had this to say:
Sorry Ross that makes no sense. Politicians simply love talking about stuff that sounds bad. Scaring the crap out of the population is what they do best as it makes people vote with the nerve endings in their guts rather than their brains.
As for the claim that economists don’t want to talk about it because they know it isn’t bad, well it is true enough to say that SOME economists, who believe very peculiar myths and fables, think exporting title to your capital base and claims over your future incomes, and spend the proceeds on consumption, is a jolly great way to run an economy……in the interests of offshore parties.
The sad truth of the matter is that most politicians do not talk about the “external sector” simply because they have swallowed great gobfuls of the bulldust being peddled by some economists.
It is also worth noting that economists in most of our trading partners/rivals think our “some economists” are bark raving mad for allowing them to manipulate our exchange rate by exporting unproductive capital to Australia in the hundreds of billions.
And just in case if by the end of the article any readers remained unconvinced that $1 Trillion dollars in foreign debt was sensible, Ross finished with a flourish that suggested that, when it came to foreign debt, it was better for the economy than broccoli. It was “….further proof we’re not living beyond our means…”
You see according to Ross, all the extra funding ‘borrowed’ from foreigners is used to fund ‘new’ investment in houses, business structures and equipment and infrastructure. All of it is productive and not a single cent unproductive, at least no sign that Ross thinks so.
One final point
One of the great chicken and egg arguments is whether the trade deficit arises because we love imports and then borrow the money to pay for them or we borrow money and then spend it on imports.
As Ross points out in the article the national accounts must balance,
but balancing accounts don’t really explain very much. Ross implies that the process starts with imports exceeding exports which is then funded by the kindness of foreigners who just love saving more than consuming. With respect Ross that is wrong and implies that decisions to consume imports are not connected to the nature of and magnitude of capital inflows.
The simplest and most logical way to understand the process is to keep in mind that when people go shopping their decisions are framed by the prices on offer and their perception of value. They do not buy and then run around looking for someone to lend them the dough for the purchase. Any ‘loan’ takes place long before the purchase and the relevant loan likely involved completely different parties to those haggling over the price of a nice imported toaster.
All of the unproductive capital inflows described above have the effect of increasing demand for $AUD above what they otherwise would be. This means that one of the consequences of the Federal Goverment and its agencies – the RBA, APRA, the FIRB (Foreign Investment Review Board) – allowing hundreds of billions of dollars of unproductive capital to flood into Australia is that the $AUD trades higher than it otherwise would.
An Australian Dollar bloated on unproductive capital inflows means that the prices of imported goods will be lower than Australian produced goods – everything else being equal. And we all know what happens when Australian production is less competitive – people buy more imports and we lose jobs and businesses offshore. It is a deplorable state of affairs.
In other words the unproductive capital inflow that drove down your mortgage rate on your massive mortgage is part of the reason that you thought the price of the imported car and other creature comforts compared favourably with the locally produced alternatives.
Is it really any surprise that we find a trade deficit is the result of allowing the country to gorge itself on unproductive capital inflows.
If you are now asking yourself whether I am suggesting that we should regulate the largest and most damaging forms of unproductive capital inflows to help ensure that the Australian dollar trades at a value that better reflects our trade performance, you bet I am.
Here is a very short and simple to do list.
- APRA should direct the local banks to immediate start to wind down to zero capital inflows associated with mortgage lending where the security for the mortgage is existing land/housing. In due course the local banks will not be permitted to borrow offshore at all in connection with residential housing. The idea that Australia cannot scratch together the capital required to build our shelter is absurd. If there remains a massive demand by foreign investors for exposure to Australian real estate, without an effective government guarantor, they can be allowed to invest in non-guaranteed residential mortgaged backed securities RMBS. They can punt at their own risk.
- The FIRB should demand that any foreign acquisition of existing corporate, infrastructure or land assets (limited to 49%) must demonstrate clear and credible plans for additional investment to expand the productive capacity of those assets. If they do not deliver within the agreed time frames they will be forced to divest. No foreigners offshore or temporary resident in the country will be permitted to buy existing residential housing assets. Only new housing assets may be purchased and they will be subject to land tax to encourage the foreign owners to make them available to rent.
- The Australian Government will introduce a system of registered title to Australian Government bonds/securities and ownership, to the vast majority of new issues, will be limited to locals. Some government securities may be still available to foreign investors but not many. As a matter of democratic control it makes sense that the government is forced to convince the locals – not foreigners with all sorts of other agendas on their mind – to invest in a fiscal deficit – assuming that direct monetisation of the deficit is not appropriate.
- If people are talking about Foreign Debt and not distinguishing between productive and unproductive capital inflows they either don’t know what they are talking about or they are trying to baffle you with bullshit.
- The majority of Australia’s Foreign Debt was not incurred for productive purposes. the vast majority was incurred in relation to three major transaction types as detailed above.
- Unproductive foreign capital inflows / Unproductive Foreign Debt kills Australian jobs and sends Australian businesses off shore.
- The sooner Ross stops talking baloney about Foreign Debt and Capital Inflows being nothing more than ‘investment’ and nice “saving mad” foreigners helping Australia unlock its potential the better.
Outstanding insight Pf!
Couple of Q’s:
1. Are there any decent charts that compare countries and their levels of productive/unproductive debt?
2. When you say direct monetisation of the deficit, what does this actually refer to?
1. Not sure but they would be interesting if they exist. I suspect that most would show high levels of debt that is unproductive.
2. By direct monetisation I mean that the RBA explicitly funds a fiscal deficit – either by just crediting treasury’s ES account or by ‘buying’ some 0% bonds direct from the govt. There is already a lot of indirect monetisation when the RBA buys govt bonds from banks as part of OMOs – but those involving paying interest etc so are an unnecessarily expensive way of achieving the same result.