Dispelling the myth about government spending

All this news about the lack of affordable housing in New Zealand - or housing at all - is followed with calls for more houses to be built. Seems like the obvious solution right? 
But the core reason behind this and many other social issues is the inequality in our society. We all, for the most part, abide by the rules that the government legislates and enforces. Those rules benefit some and harm others. The people that benefit the most from these rules - the rich and powerful - have the resources to influence and bend those rules even more in their favour.
We have elections that allow everyone to vote. In order to ensure that the bulk of the electorate do not vote in their own interests, the rich and powerful ensure that all sorts of misinformation gets disseminated throughout the population. And so we end up voting in governments that really only act in the interests of a few, whilst placating the masses enough to avoid complete social breakdown.
But it's easy to see through all of the bullshit when armed with knowledge and the ability to think critically.
One of the most effective myths (that allows the elite to exploit the rest of us) is the belief that the government is restricted in the amount of money it can spend. When you hear a minister saying "we don't have an unlimited amount of money to spend" when discussing health, education, housing or social welfare, they are, quite simply, bullshitting. Aside from the fact that the government is not fiscally constrained, you have to ask the question "Ok, where do the billions come from to build all the new motorways?". The answer: the government simply spends the money! They don't have to "find" the money; they can simply spend it. 
Before we can really solve any of these so-called "intractable" problems, we have to dispel this myth.

There's a lot in just one clause

In 2008, not long after John Key became Prime Minister, Bill English sent a letter to the then governor of the Reserve Bank of New Zealand (RBNZ) proposing a change to a clause in the Policy Targets Agreement (PTA). The PTA is an agreement between the Minister of Finance and the RBNZ that outlines RBNZ policy. Bill proposed that clause 1b be changed from:

The objective of the Government's economic policy is to promote sustainable and balanced economic development in order to create full employment, higher real incomes and a more equitable distribution of incomes. Price stability plays an important part in supporting the achievement of wider economic and social objectives.

To:

The Government's economic objective is to promote a growing, open and competitive economy as the best means of delivering permanently higher incomes and living standards for New Zealanders. Price stability plays an important part in supporting this objective.

The proposition was accepted, a new PTA was signed, and that PTA is still current today.

I've highlighted key parts of the original clause that have been removed, and for me this is very telling. It is clear to me that the objective of the current government's economic policy does not include reducing inequality or unemployment; otherwise why would Bill wish to remove these parts? Note that you can have higher incomes and living standards (as stated in the new clause) on average, without necessarily reducing either unemployment or inequality. At worst it suggests the government doesn't care about such things. At best it suggests the government trusts "the market" to deliver.

Also note that the objective of the current government's economic policy is not focused on actually achieving outcomes (as was explicitly stated in the previous clause), but instead is interested in promoting the idea of a "growing, open and competitive economy" as a way to achieve those outcomes. This distinction is subtle, but important as it points to a policy that is all about selling an idea to the public, regardless of whether or not that idea - when implemented - is actually any good for the public!

John Key telling porkies about Government debt....again

John Key today (14^th April 2015) on Newstalk ZB, talking about government spending, with my commentary in italics:

"When we live within our means, we are in a situation where we’re not borrowing internationally to run the government books."

Wrong. The government doesn’t really borrow from anyone. When the government issues debt, it simply swaps one type of government liability (New Zealand government bonds) for another (New Zealand dollars). And when the government does this, the RBNZ (an agent of the government) may perform liquidity operations that result in the RBNZ creating New Zealand dollars out of thin air to ensure there is liquidity in the banking system so that banks and other institutions can “purchase” the bonds.

"We are in a position where, you know, the international financial markets like that."

Wrong, if by that, John means that the financial markets will demand higher interest rates from New Zealand’s government bonds. This doesn’t actually happen at all, as the RBNZ effectively sets interest rates along the yield curve through the OCR and commentary on future OCR expectations. There is really no relationship between interest rates and levels of government debt for countries that have own free-floating, non-convertible currencies.

"And we’re also in a stronger position for a rainy day if that comes and, you know, happens again."

Wrong again! The government can - and will always be able to - spend no matter what the level of outstanding government debt is, regardless of the prevailing economic climate. 

It's not just about the government!

Another issue of the Listener, and yet another article full of supposed truths about government debt  ("Another day older & deeper in debt", Money, June 28). As I've stated before, a government with a free-floating, non-convertible currency is nothing like a household or a business. The New Zealand Government does not have to balance its books. It doesn't have to save for a "rainy day". Ever. End of story. But even if we ignore this fact, by only focusing on the government books, the author of the aforementioned article is ignoring the rest of us out here in non-government land. 

The New Zealand economy can be seen as having three distinct sectors. The first two sectors, the public sector (government) and the domestic private sector (NZ households and firms), make up what is commonly called "New Zealand Inc.". The third sector is the foreign sector (the rest of the world). 

The first thing to realise is that this is a closed system: the combined cash-flows of these sectors must net to zero over any time period. In other words, if any of these sectors run a surplus, then at least one of the other sectors must run a deficit. This is basic accounting.

Currently we - the domestic private sector - spend more NZ dollars than we earn. Consequently, we collectively run a deficit that must be funded by the other two sectors. Now here's the key point: if the government runs a surplus, then the domestic private sector must fund its deficit entirely by borrowing NZ dollars from the foreign sector. This means NZ banks borrow more from off shore, and we borrow more from NZ banks. On the other hand, when the government runs a deficit, we in the domestic private sector don't have to borrow so much from the foreign sector as almost all government spending goes to the domestic private sector, and therefore reduces our borrowing needs.

Simply put, when the public sector (the government) restricts spending, it forces the domestic private sector (that's us) to borrow more from the foreign sector. Any decent analysis of the New Zealand economy should take this into account...

Election year and government spending

Brian Easton sparks up debate on government spending (“Lolly scramble, anyone?”, Listener, June 14) but contains it within – the author would have you believe - certain unquestionable facts.

A government with its own flexible, free floating, non-convertible currency (like the New Zealand government) is not like a family or a business. It simply does not have the hard constraints that households and firms have. Examples of governments with their own sovereign currencies are New Zealand, US, UK, Australia, Canada, and Japan (amongst others). These governments do not need to build reserves for unfortunate events. Have any of these governments had to have reserves in store in order to run large deficits since the GFC? No. Have interest rates in these countries spiked because of the increase in the level of government debt? No, and remember that Japan has been running large deficits for over 20 years and interest rates have hardly moved at all.

Here is the key point: In all of these governments I’ve mentioned, the treasury and central bank co-ordinate activities in such a way as to ensure that there are always buyers of government debt. The New Zealand government can never run out of money (unless that is their intent – think about the US debt ceiling!). The New Zealand government can always afford to purchase goods and services in its own currency.

This is not to say that the government should spend without limit - too much spending in unproductive areas can cause too much inflation. But in the countries I’ve mentioned, the correlation between increasing government debt and subsequent inflation is non-existent. I would argue that we focus far too much on inflation, and not near enough on health, education and tackling unemployment.

Portugal, Ireland, Italy, Greece, and Spain (the so called “PIIGS”) are in a completely different situation because they’ve adopted the Euro currency and no longer have the flexibility they used to have when they had their own sovereign currencies. In fact, in 1992 when Italy still had the Lira, trader Warren Mosler famously convinced the Italian government that they did not have to succumb to the austerity pressured on them by the IMF because of the very fact that they had their own free floating, non-convertible currency. As it turned out, the Italian government said they were fine (because they were), yields dropped on the government debt (as the market had mispriced the risk), and austerity measures were not necessary.

The conclusion is that restricting government spending for the purpose of targeting surplus or a specific level of government debt is, in and of itself, pointless and potentially damaging.

Does a surplus matter?

The following is taken from the National Party website. They are talking about the virtues of running a goverment surplus. Often politicians will make claims with little or no justification, so I invite you to give me an explanation: tell me why the underlined statements are true and necessarily follow from running a surplus. Or, if you don't agree, explain why you think they've got it wrong. 

Thanks in advance!

Why a surplus matters
Operating in surplus is important for our future.  It will help us keep interest rates lower for longer, which is the single biggest cost to most households, and it helps take the pressure off our exchange rate, which is good for our exporters.Getting our books in order means we will owe less to overseas lenders, which will help ensure our economy is stronger and in a better position to handle future economic shocks.  This is important because the global economic outlook remains uncertain.Operating in surplus also means we can invest in other areas that matter to Kiwi families.

Letter to the Listener

I have two questions relating to a recent editorial ("Future proofing", July 27).

1) What is the "fiscal crisis" that we need to avert? The treasury talks of a shortfall. But what does that mean? It simply means that the government's spending is projected to be more than its revenue in the future. Which means that the government will need to run deficits. So what? Our government (like the US, UK, Japan, Canada, and Australia) can actually run deficits in perpetuity. There is no hard constraint other than a self-imposed one. And I'm not talking about printing money here. All governments that have their own free floating currency can spend without constraint. The Treasury and RBNZ co-ordinate activities such that there is alwaysbuyers of government debt. From what I can tell, many economists don't know this and still think we live in a gold-backed currency world, which effectively ended in 1971. Today the government bond market really exists just to provide the private sector with risk-free savings! 

The only real concern that the government has is the possibility of high inflation. If there is too much spending, without a comparable increase in production, then we will get inflation (or so the story goes). But we have to ask ourselves what is the likelihood of this given that a) we are in the biggest global downturn since the Great Depression; and b) there is idle capacity in our economy (just look at the unemployed). Japan has run big deficits for 20 years without any inflation and debt/GDP going to over 200%. And has the sky fallen in? No. Are they still providing excellent social services? Yes. In fact, Japan score very well on most of the measures that make up The Economist's Quality of Life index, and the UN's inequality measures. 

2) Why don't we focus on the (lack of) reliability of long-term predictions? Even if someone can convince me that there is an impending fiscal crisis (unless we make sacrifices now), should we weigh so much on these forecasts from the Treasury? Inside an investment prospectus you will often see this disclaimer: "past performance does not guarantee future performance." We need to apply this to financial forecasts that come from economists too - and this includes staff at the Treasury! In general, they don't have a great track record. It's not their fault - it's just incredibly hard to predict the future!