Both the IMF and the OECD say that monetary policy is largely exhausted so fiscal policy should now be used to ramp up economic growth held back by the triple Ds of high Debt, ageing Demographics and disruptive Digitisation (including robotics). Australia’s Reserve Bank has come to the same conclusion.
That suggests government finance ministers must replace central bank governors as the ringmasters of the economy. Governments should increase spending on infrastructure and give tax relief to boost economic activity since central banks have cut interest rates as far as they can.
But most governments since the GFC have run large operating deficits that built up a mountain of global public debt. Finance ministers are reluctant to borrow more for fear of debt charges squeezing out essential spending on education, health, law enforcement, transport subsidies and social security when interest rates normalise.
In Australia this issue has now come to a head. The Governor of the Reserve Bank, Phillip Lowe, has urged the government to start pump priming the economy by sponsoring a massive capital works program. That would lift aggregate demand given that over-indebted households are underspending. Lowe is right.
By contrast, the Treasurer, Josh Frydenberg has vowed to maintain a fiscal surplus (covering both operating and capital accounts) since this is Australia’s best safeguard against another global financial meltdown. In such a crisis economies with a Triple-A credit rating like Australia stay buoyant. Why squander that advantage? Frydenberg is also right.
So how can we resolve this standoff? One possibility is the mechanism used to revive the German economy during the great depression of the 1930s. Hitler is an awful role model, but his monetary policy is worth studying since it reconciled fiscal and monetary policy without adding to public debt.
The Third Reich initially funded major capital works and military rearmament by paying contractors with debentures issued by the Reich Finance Ministry, but it then switched to using promissory notes issued by a privately owned limited liability company, referred to as Mefo notes. In both cases contractors accepted the securities because they were convertible into the currency by the central bank, the Reichsbank. By 1939, there were 12 billion Reichsmark of Mefo notes, compared to 19 billion of normal government bonds.
The 1936 Berlin Olympics marked Germany’s return to being a superpower. That was made possible by Mefo notes. As was Germany’s construction of vast autobahns to accommodate the mass production of a people’s car, the Volkswagen. Meanwhile the rest of the world suffered economic hardship.
Fast forward 80 years. Governments today could issue equity (for example share certificates) against public works and request their central banks to buy them. This would sidestep debt limits. That’s not presently permissible for the US Federal Reserve, though its former governor Janet Yellen ventured that the Fed should be given the authority to buy stocks in a recession.
Government shares unlike bonds would not pay interest nor add to public debt which is important because sovereign debt across the OECD area has jumped from US$25 trillion in 2008 to US$45 trillion in 2018.
Government shares would only pay dividends to the central bank if the public works they funded generated earnings, which for social infrastructure such as public schools, hospitals and prisons would be nil. That would not matter since central banks don’t need the income.
Does this proposal sound crazy? Sure does, but so did Quantitative Easing (QE) when it started because it was tantamount to central banks printing money to buy government bonds and other securities mainly from banks. The banks in turn used the proceeds to lend largely for asset speculation and corporate share buy-backs because most businesses refused to borrow for new plant and equipment.
As we know QE saw bond, property and share prices soar, but there was little expansion of productive capacity and earnings. Financial centres flourished while economic hinterlands struggled. The asset rich enjoyed rising share and property prices. Ordinary people whose wages stagnated, revolted by electing Trump, supporting Brexit and flocking to populist parties across Europe.
That’s why the burning question for the developed world (including Australia) is what should replace QE given that we have reached a monetary and fiscal impasse? My suggestion is QI (Quantitative Investing), whereby central banks print money for the public good rather than private gain. Any return to QE which increased economic and social inequality could further strain class, regional and inter-generational tensions. That could imperil liberal democracy.
Funding much needed infrastructure through government share issuances to central banks would have an economic spinoff without adding to the public sector’s already high debt. As such it would be less worrying to government finance departments than issuing more bills and bonds.
Of course no politician could credit the Third Reich with this brainwave. In Trump’s case he could say he was drawing on the concept of Greenbacks used by Abraham Lincoln to fund the American Civil War. Greenbacks were unbacked Treasury Notes (without a coupon) issued as legal tender.
Normally a national Ponzi scheme such as this would be inflationary, but if the developed world is in a liquidity trap exacerbated by high debt, an ageing population, a shrinking workforce and low productivity gains, then weak aggregate demand would be bolstered by a large infrastructure program funded by government share certificates bought by the central bank. It would be preferable to governments loading themselves up with more debt given that it is already excessive.
The latest IMF data shows global private and public debt as a proportion of world GDP increased from a peak of 200 per cent just before the GFC to 225 per cent in 2017. Instead of deleveraging after the debt crisis of 2008 the world went further into hock. In Australia’s case our public sector needs to keep a cap on its debt to offset household debt which as a proportion of net income is nearing the highest level of any nation in the world.
That’s why any fiscal stimulus resorted to in Australia needs to be debt neutral. Quantitative Investing (QI) as I have outlined here offers that possibility. Since Australia is one of the few developed countries that did not resort to QE, the RBA’s balance sheet is not bloated with financial assets. Hence it has scope to buy state capital works share certificates that would fund vital public transport, health and education facilities. And when the economy eventually rebounds it could cease such funding while continuing to hold a stake in tangible physical assets with ongoing public benefit.
Since most capital spending in Australia is by state governments the RBA could insist any works it funded pass an objective economic cost/benefit test applied by Infrastructure Australia. Such a test is very different to a commercial cost/benefit analysis since most public works don’t generate revenue.
Percy Allan is a public policy, management and finance adviser and a former Secretary of the NSW Treasury and Chair of the NSW Treasury Corp.