Finance

Why the Rudd Government will struggle to spark the economy: Alan Kohler

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Memo Kevin Rudd: This is a capitalist system, not a socialist one. That means although the state makes plenty of noise and gets a lot of attention, its effect is marginal.

Memo Kevin Rudd: This is a capitalist system, not a socialist one. That means although the state makes plenty of noise and gets a lot of attention, its effect is marginal.

Sorry to break it to you folks in Canberra, but the business of government ain’t what it used to be. And frankly, that’s mostly due to your own efforts during the 1980s and 1990s – privatising everything and letting the market take over.

Well, it did take over and the state sidelined itself. And now look what’s happened.

I don’t want to sound like a commie or anything, but I think we can conclude that much of ideological underpinnings of the Reagan/Thatcher revolution – centred on the notion that the private sector always does things better than the public sector – was not entirely correct.

Anyway, too late for that now. The result is that governments are largely spectators of events, not players. They’re very engaged spectators, to be sure, and they’re doing a lot of noisy barracking, but bankers and industrialists are the ones on the field.

Monetary policy has been spectacularly unsuccessful for years, and still is. Fiscal policy has been in a coma for decades as politicians in Australia vied to have the biggest surplus, while in America they vied to have the biggest deficit through ideologically driven tax cuts.

And now politicians are trying to wake up the coma patient. The eyelids are fluttering, but that’s about it.

It’s perverse, and not a little pitiful, for the Rudd Government to be borrowing money, sending out $1000 cheques to people and exhorting them to spend it, please, to try to keep Australians employed.

Treasury apparently estimates that 70% of the money will be spent between now and the middle of next year, which will add 0.7% to GDP and “create” 75,000 new jobs. But we know all about the accuracy of Treasury estimates.

Too much spending and borrowing is how we got into this mess. Now, as a result of a series of shocks to the banking system brought on largely by the banks themselves, a reduction in borrowing – deleveraging – is being forced on the world.

So we are now painfully discovering the extent to which employment has been supported by debt, both directly and indirectly.

The first to go are those directly employed in the finance business. Hundreds of thousands of banking and finance jobs are being cut in London, New York, Zurich, Tokyo and Sydney.

Skyscrapers are simply being hollowed out as the “debt industry” shrinks.

And then there is the other side of the debt industry. It turns out, for example, that much of the employment in childcare was financed directly by borrowings that were supported by imaginary intangible assets. The collapse of ABC Learning and CFK has exposed that, so a series of unprofitable centres will have to close and the staff will be thrown out of work.

Employment in housing and the motor industry has also been financed by debt because the products usually require the buyer to take out a loan. The reduction in lending, and in the case of car dealers the complete disappearance of two lenders from the market, is reducing employment in those industries.

Retail consumer spending in general has been financed by debt, and as a result household debt in Australia has increased from about 50% of disposable income during the last recession 18 years ago to 160% today.

Spending will now be cut to reduce debt and retailers are now reducing staff and closing stores.

Likewise, many companies now find themselves with too much debt – either because it’s too expensive or because it can’t be refinanced when it falls due – and must reduce dividends, cut staff and/or sell assets.

That is reducing the value of both property and shares.

In some cases, as Gerry Harvey of Harvey Norman highlighted in the article here yesterday, commercial landlords are responding to the pressure from their banks by trying to increase rents. That is simply accelerating the retrenchment of employment.

Where the new debt equilibrium will be is anyone’s guess. Markets have a tendency to overshoot and in some ways the deleveraging now underway has the feel of something entirely out of control.

On the other hand, there’s no rule that says household debt must return to 50% of average income. Interest rates are going to be very low for a long time, so servicing debt may not be a problem – although there is a huge mismatch between the market price of wholesale credit and the official cash rate, so mortgage rates are not falling as quickly as central banks are cutting the cash rate.

To get around this, and to avoid the nightmare of persistent deflation, central banks are now starting to shift their strategy towards “helicopter money” – that is, simply printing cash and getting it out there.

If the banks won’t increase the money supply through credit creation, central banks will have to do it directly, not by literally dropping it from helicopters but by buying any kind of assets – not just government bonds.

In that context there is nothing wrong with the Rudd Government sending out cheques to Australia’s poor families, except it’s not enough and it won’t be spent.

In fact, it shouldn’t be spent. The sooner we all get our credit card balances, car loans, mortgages and corporate debt down, the sooner businesses will start hiring again.

Governments must provide a safety net and, to an extent that is sensible, can become an employer of last resort. Not painting rocks on the side of roads, but building infrastructure.

And as a result new model for organising society will develop, with more government involvement. Could be worth a try, although they’ll eventually stuff it up again too.

This article first appeared on Business Spectator

 

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