Friday, March 29, 2024

The more the federal government spends, the poorer we all become

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“This budget is carefully calibrated to alleviate inflationary pressures, not add to them. In this environment, inflation remains our primary economic challenge. It drives rate rises; it erodes real wages. Which is why this budget is carefully calibrated to alleviate inflationary pressures, not add to them.”
Dr Chalmers, Treasurer

Nothing to see here. Move along. The $20bn spending spree with increases to JobSeeker payments, rent assistance, energy bill subsidies, cheaper medicines, and a boost to wages – if they are not inflationary, then what economic school does the Treasurer hail from?

Remember Rudd and his Treasurer Wayne Swan? He spent like a lunatic to get us through the financial crisis. Then along came Abbott trying to fix the mess of debt and deficits before inflation caught on, but he got turfed by Turnbull – who was closer to the left than the right – and the rot started in the Liberal Party as they forgot their values – less government is better than more.

So today we see debt and deficits looming for the next decade despite a micro bonus of a surplus off the back of a post pandemic boom.

But the real enemy today is inflation.  Everyone in Australia is poorer by 6 per cent because of inflation.

Forget the $1 a day increase in rent subsidies or the $20 extra a week for the unemployed. By not tackling inflation in the last budget or this all these people will be 10 per cent poorer by the end of the year.

But that’s ok because most people don’t understand what a hideous cancer inflation is, eating away at your wealth and income.

What is it about inflation that federal politicians do not understand?  The more the government taxes and spends, the more pressure it puts on inflation and the poorer we all get, unless you are one of the lucky ones whose income is indexed to inflation, or you have lots of debt locked in at low interest rates for a long time (as the federal government has).  Anyone want to lock in at 3.71 per cent for their current 15 year bond or 4 per cent for a 30 years when inflation is running at 6 per cent?  Safe as houses, only don’t expect to buy a house in 30 years with the $500,000 you invest plus the interest when this generation of economic illiterates are in power. 

Funny how the old federal government pension scheme factored inflation into their returns as those who came through the Whitlam era recall how inflation eats into pensions and savings.

Unfortunately this generation of politicians has no recollection of value destruction so is spending as if there is nothing to see and nothing to fear.

Historically there is a close correlation between high federal government spending and inflationary pressures.

Federal spending is currently close to a record high, and gross government debt is currently on track to increase from $1 trillion this year to $1.455 trillion by 2030.

Anyone remember the Treasurer that got us to zero debt and deficits? Answer: Costello, back between 2006 and 2009 who got spending down to 24 per cent of GDP.

Government spending today will be locked in at 27 per cent of GDP through to 2025-26.

So what does 3 per cent matter? It’s all for a good cause – climate change, reconciliation, unemployed (during record worker shortages) etc.

But 3 per cent does matter out of a $2.2 trillion economy when – like the last person wanting to buy the last landcruiser when landcruisers are limited – someone with a pocketful of cash pushes prices to stupid levels. That’s what the federal government is doing.

Inflation occurs when government runs persistently high deficits and incurs excessive government debt. According to Hoover Institution economist John Cochrane, a public that expects the government will not pay back its debts will act in ways that drive up inflation now, not in the future.

That is, they will spend now rather than save as their money is evaporating in front of their eyes.  As a former exchange student in Brazil back in the 1980s, I can tell you what a 2000 per cent inflation does to the middle class. It wipes them out. No new cars, no housing renos, no travel, no nothing; just a desperate search for gold or US dollars to hide in the house.

Our 7 per cent inflation is entering people’s mindsets and they are responding accordingly by demanding higher wages or subsidies from government.

Thus higher inflation is slowly eroding people’s savings and driving increased wages pressures which are passed on to those who can least afford it.

Ultimately, the government has a cunning plan to deal with its own debt by devaluing the debt itself, that is, through inflation. In the meantime it throws a few dollars at the poor to keep them sweet at the ballot box.

It’s a win win for government; they rack up the debt and let inflation eat away at it and look generous to the battlers. It’s a clever strategy so long as the peasants don’t cotton on and start spending like lunatics to get in front of the government.

This is known as the Fiscal Theory of the Price Level, not that anyone other than Dr Chalmers knows it.  He is a Dr, not in medicine or economics, but political science, which is the dark art of understanding how to convince people to do what the government wants them to do without them revolting.

This is the Treasurer that history will record has baked inflation in at its highest rate since the inflation target band of 2 to 3 per cent was first established in 1993.

By the end of 2022, inflation was at 7.8 per cent. As of March 2023, it remains at 7.0 per cent.

To date, the Reserve Bank of Australia has raised the cash rate target on ten consecutive occasions between May 2022 and March 2023 under the watch of this Treasurer, with a further cash rate target rise in May taking it to 3.8 per cent, which means your farmhouse credit card bill is double or triple that.

The Institute of Public Affairs, a worthy think tank that delves into these matters, finds that a 1 per cent annual increase in federal government spending is associated with a 0.15 percentage point increase in household mortgage rates.

Economist Chris Richardson uses a rough measure that, to reduce interest rates by 0.25 per cent, the government would have to take $6bn out of the economy through fiscal measures.

The reverse is also relevant. For every $6bn spent, one could expect the central bank to whack another rate rise on home borrowers.

According to the budget ­papers, $12bn of the $20bn in spending measures over the next four years will roll out over the next 12 months – suggesting the budget is being frontloaded just at the wrong time.

Between 2020 and 2022, federal government spending has increased by 9.6 per cent per year on average, which equates to a 1.41 percentage point increase in the typical monthly household mortgage rate.

So, if you owe a million of farm debt, the federal cash splash has cost you $14,100 extra in interest.

If you have a grain cheque in the bank of one million dollars, an inflation rate of 7 per cent inflation less the nominal 2 per cent (as the acceptable inflation rate) means you have gone backwards by  5 per cent of $50,000.

 Your money can buy $50,000 less of goods and services, call it one less 5 year old landcruiser.

Mind you, you get to add back the extra 1.5 per cent higher deposit rate of which you lose around a third in tax, so you are down a 10 year old landcruiser as a dividend on your million dollars in the bank.

 Hence the rush to spend money when inflation is so high; better to buy a new landcruiser than leave the money in the bank.

The only way you are a winner is if you borrowed to buy the neighbours farm at say 4 per cent interest for 5 years and you can sit fat and happy like the federal government watching inflation erode your debt. 

If you didn’t, then you can look forward to chronic pain as this federal government has a long list of spending priorities as reflected in the next 9 years of forecast deficit budgets.

Outside of raiding your super and taxing you through bracket creep, there are not many options to rein in government spending, other than going slow on the already incredibly slow roll out of the new subs.

If you ever wondered why Argentina – which produces double the amount of grain and cattle – has no NDIS, Medicare or hope of buying nuclear submarines, then it’s because they have a long list of Treasurers who studied the same left wing economic theory as Whitlam, Jim Cairns, Rudd, and Wayne Swan, which is, inflation does not matter.

So, my takeaway on budgets is, the only ones that count are the ones linked to the size of the government’s share of the economy.

Two rough rules of thumb. Firstly, the government should never have its hands on more than one in four dollars circulating through the economy, so look for the size of budget compared to the GDP,. It should be below 25 per cent, if not, then the budget is a bad one (unless it’s war time).

The other is, look at the forward expenditure numbers (which is always a figment of the Treasurer’s imagination). They should be a number in the black not the red, again, unless there is something serious happening, like a world war or a depression or a really serious pandemic, not the cough and cold one we just had.

Other than looking up if they have exceeded the one in four rule and if the forward estimates bottom lines are in red and not black, you can forget reading the 15 budget documents totalling over 1000 pages, as all they will do is try to convince you that the government can spend your money better than you can and that inflation is nothing to worry about.

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