#kickthecandowntheroad

Which government racked up the most debt in Australia?

Irresponsible! How conservatives used to hammer the Rudd/Gillard/Swan Labor government for squandering the massive surplus left by the Coalition under Howard/Costello. Yes, it was huge, but our current Abbott/Turnbull/Morrison Coalition is supposedly responsible for over half of the total of all gross debt since 1854 according to the Australian Office of Financial Management (AOFM). Is this true?

A question posed from a subscriber to FNF Media was, “what has driven the Australian debt since 2013?

First, a preamble.

We’ve seen this picture before. The Obama Administration almost ran up more national debt than all 43 previous administrations combined. From $10.699 trillion to $19.976 trillion. Federal debt as a % of GDP expanded from 64.4% to 105.2%. The latest count under Trump is $22.7 trillion, or 105.4%, virtually unchanged.

It is not an uncommon trend in other countries either. EU central government debt has grown from 52.6% in 2007 to 89.3% today. Japan has jumped from 134% to 196.4% respectively.

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The RBA starts off with an interesting chart (above) which explains how the steady lowering of cash rates triggered the explosion of federal debt. From the post-2000 peak of 7.25% (2008), interest rates are now at 0.75%. Since Sep 2013, we have been sub 2.5%.

Bonds

Note the Abbott Coalition took power in September 2013. According to the AOFM, at that time, Australia had $301.8bn in outstanding federal government debt. AOFM also reports the Dec 2019 outstanding figure was $556.6bn. Mathematically, if we assume that all previous administrations to Sept 2013 summed to $301.8bn that would mean the most recent Coalition would be responsible for 46% of the total amount of all debt issued since 1854.

If we look at it from a % of GDP perspective, gross debt in Australia has risen from 30.5% to 41.4% of the total between 2013 and 2019. Note that in 2007, Australia’s gross debt was only 9.7% of GDP.

What ultimately matters is “net debt.” Although even that is predicated on the value of assets being fairly treated at a particular point in time. In a sharp economic downturn, assets values can implode, while liabilities remain as they are. Net liabilities can move on a dime.

The Howard Coalition lost office in November 2007. At that time, the net surplus was +A$22.1bn. When Labor lost in September 2013, net debt was $174.6bn. Therefore the net increase under Labor was $196.7bn. Since that time, December 2019 net debt now sits at $403.0bn. Inflation-adjusted, it is probably on a par with the Coalition’s scorecard.

If we calculate the net deficits between 2012-13 and 2018-19, it sums to $184.1bn. So versus the $202.6bn in debt issuance, it is largely consistent with the first chart.

Net interest payments on interest-bearing liabilities according to the Department of Finance were $14.008bn on $306.228bn of debt or 4.57% average interest rate in September 2013. The projected interest bill for the FY2019/20 recorded in December 2019 was $18.215bn on $642.5bn or 2.83% average interest rate on that debt. So double the debt with only 28% more in interest costs.

Easy money has allowed lazy deficits. Although we could just blindly believe our government that the net debt will be wiped out by 2029/30…too easy…then again this is the dream world government departments live in.

Don’t forget we’ve been told by the BIS that central banks will be the “climate rescuers of last resort” despite reckless monetary policy where, in 2019 alone, we’ve had 71 rate cuts conducted by 49 central banks, laying the foundations for over-consumption and racking up excessive debt levels. You can read more about that here.

Net Debt

Now our authorities can use the half-truth of bushfires and the Coronavirus to explain away any weakness in the current quarter. Never mind, a bit of debt-fuelled government spending will be turned on again to save us and the budget papers, which so few people read, will see the the ‘net-debt’ projection pushed out another decade in the hope we won’t notice.

Australia remains in ‘relatively’ good shape but the trend is hardly one to take comfort from if the Australian government’s thinking remains that low-interest rates can let it kick the can down the road indefinitely.

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Just how far behind the curve is the Fed?

As the Fed raised its Fed Funds Rate to 1.5~1.75% overnight, one has to question just how far behind is it? 3M Libor rates have surged from 0.5% in 2016, c.1% at the start of 2017 to 2.27% today, the highest levels since 2008.  Normally Libor minus Overnight Index Swap (OIS) rates don’t diverge so much without causing a credit issue. The gap is effectively the market price over and above the risk free rate. At the time of the GFC, the Libor-OIS spread hit 3.5%, with 1% being the detonator level. While it is currently at 0.54% spread, it has risen consecutively for the last 32 sessions.

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As Libor drives corporate credit recycling, with corporate debt piles approaching record highs and average credit ratings the worst they’ve been in over a decade (chart below depicts Top tier as AAA and bottom tier as BBB-) we could see the Libor-OIS spread keep expanding.

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What could be causing this? If we think logically the US Treasury has to refinance $1.5 trillion over the next 12 months and $8.4 trillion over the next 4 years. Add to that a Fed looking at quantative tapering and a less eager Japan and China as buyers of US$ federal debt then the corporate will undoubtedly get crowded out. The demands for refinancing are not being met with the supply of funds.

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Of note, the St Louis Fed reports the YoY increase in inflation reported by the CPI in the US in Feb 2018 was 2.3%. The 10yr breakeven inflation rate is around 2.08%. CPI ex food items is still at 1.9%. In any event the US remains in a negative real yield environment.

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The Fed can bang on all it wants about healthy growth, full employment but the depth of problems stored up is getting worse. $9 trillion in unfunded public pension liabilities, $67 trillion in combined public, private and corporate debt…

…many are recently talking of the huge pent-up profit boost to banks which have had such compressed spreads for so long. Indeed that all makes absolute sense from a theoretical (and to date practical) reasoning but banks like those in Australia up to their gills in mortgage debt, rising spreads have far nastier implications for blowing up balance sheets than boosting P&L accounts.

In a sense it is almost futile to call central banks as being behind the curve. The failure to take the harsh medicine of almost two decades ago is gathering momentum in so far as there is not much can left to kick down the road.