ECONOMIC AFFAIRS: by Colin TeeseNews Weekly
Australia's foreign debt - myth and reality
, March 31, 2007
Like the unacknowledged elephant in the room, Australia's ballooning net foreign debt - now $520 billion - has been steadfastly ignored by the experts for too long, despite its potential to jeopardise the country's future prosperity. Colin Teese reports.Under its new governor Glenn Stevens, the Reserve Bank of Australia has wasted no time in allowing views to be advanced which amount to a justification of the size of Australia's external debt obligations. It takes the form of a commentary released by two of the Reserve Bank's staff members.
Of course, it adds the routine qualification: that the views expressed are the authors' own and not necessarily the Reserve Bank's. But I think we can rest assured that the views would never have been advanced had they been at variance with current bank orthodoxies.
Can you imagine, for example, any employees of the Reserve Bank putting together a paper condemning the prevailing orthodoxies relating to deregulation and free markets?
To any independent observer, the real concern is that the issue of Australia's indebtedness is, in fact, controversial. And it seems, at least to this writer, that the Reserve Bank and its officials should stay out of any public debate about it.Obligation
As presently understood, the RBA's function to is to exercise its power over monetary policy (that is the setting of interest rates) to contain a defined interpretation of inflation within prescribed boundaries. (Incidentally, its charter also requires that it maintain full employment, but that obligation has been ignored - at least for the last 20 or so years).
So exactly what is it that the two Reserve Bank officials are trying to tell us about Australia's foreign debt? Nothing new, really. Nothing more than what amounts to a very carefully constructed side-swipe at those who express concern about the level of our debt, and who expose the real reasons for it.
There is no recognition of the true nature of the debt - no recognition, for example, that, in large part, the debt being undertaken is used to finance consumption rather that investment.
The distinction is, of course, fundamental. Borrowing to fund productive investment is to be encouraged. Such investment, once it becomes productive, if properly directed, can be expected to generate offsetting export income. Borrowing for consumption serves no such beneficial purpose. Indeed, the latter serves only to underline our incapacity to pay for the imports we desire.
According to the authors of the paper, what they characterise as a "consenting adults" view of the debt issue seems to have taken hold within the community. Certainly, those of this view point out, correctly, that the debt does not relate to accumulation of obligation by governments - either state or commonwealth. Rather, it consists of nothing more than the aggregation of privately arranged commitments between individual borrowers and lenders (the so-called "consenting adults").
Such debt, they further contend - incorrectly - carries no implication for the economy as a whole, or for the wider community.
They further contend - again incorrectly - that this debt should be disregarded by governments charged with the business of managing the economy.
No doubt, they, and others like them, take comforting reassurance from such contentions. In doing so, however, they skate over a number of decidedly uncomfortable concerns.
The two officials of the Reserve Bank were careful to advance the "consenting adults" proposition in such a way that did not directly suggest that they actually supported it. But since they made no attempt to deconstruct the problem, the clear assumption was left that they were not unfavourably disposed towards it.
They also managed to imply that this view was widely accepted. This cannot possibly be so. A large section of the community is, quite obviously, not technically equipped to evaluate the idea at all.
Of the remainder, all of those attached to current economic orthodoxies would, no doubt, be gathering in an uneasy consensus around the "consenting adult" idea - not so much for its good economic sense, but because, so long as one is captive to the ideology of unregulated free market absolutism, there is no acceptable way of dealing with the problem of escalating debt.
In that kind of closed system, any excess on the consumption import bill, unable to be met by export earnings, must be made up by offshore borrowings.
Fortunately, there is another body of informed opinion not utterly committed to undiluted market solutions. This group is deeply concerned about the impact of this growing and obviously uncontrollable debt obligation which our country is accumulating. It insists that the debt is - and must be - of concern for both the economy and the wider community. Further, the fact that the debt is privately contracted rather than reflected in commitments by governments does nothing to safeguard the economy or the community from its future impact.
In support of its contention, this group points to the outcome of the Asian financial crisis of the late 1990s. Most of the debt concerned was privately contracted, but that did not prevent all of the national economies suffering grave consequences when fickle lenders decided to withdraw their funds. Indeed, the International Monetary Fund made it clear to the Asian governments concerned that the fund believed they had an obligation for any defaults by borrowers.
For the economies concerned, the full impact of the crisis was devastating. It is noteworthy that those Asian economies which most quickly restored economic health were those which disregarded the IMF demands and followed the example of Malaysia and re-regulated financial transactions.
A similar crisis could engulf Australia should our lenders decide, for what they might consider good reason, to call up their loans.
That is a further concern here which in no circumstances should be ignored. It may be that lenders dislike certain policy attitudes, which an Australian government believes to be in our national interest. They may well apply pressure on our government to change its policy under threat of calling up their loans unless the government accedes to their wishes. Foreign indebtedness, if we are heavily dependent upon it, could thus end up impacting upon our sovereignty.
These are not the only inescapable consequences of an undue reliance on foreign debt, especially when it is attached, not primarily to productive investment, but to the purchase of consumption imports.
The Reserve Bank is supposed to set interest rates in such a way as to keep certain consumer price inflation measures within pre-determined limits. If the economy is running too hot, interest rates are increased in an effort to slow it down; if growth needs to be stimulated, then rates are lowered to encourage economic activity.
But in doing this, the Reserve Bank can work only with the material at hand. Investors demand what they judge is a reasonable interest rate based on their assessment of the risk entailed in the investment, plus what is needed to cover the prevailing inflation rate. That's the base rate the bank has to work with.
In Australia's case, they require an extra premium on the risk assessment because of the level of our debt. At the moment, they are quite happy to lend us money, but they add a risk premium of about two per cent more on our borrowings.
Put another way, if housing loans are currently running at 7 per cent in Australia, they would be only about 5 per cent if we did not have our current level of borrowings. This is not merely assertion. It can be verified by checking the rates in other OECD countries.
It may be true to say that our interest rates are at historically low levels. But rates are historically low in most of the OECD countries because of low inflation. But it is the international comparison that is really interesting. Compared with other low-inflation countries, our rates are two percentage points higher.
Consider what this means to our average home-buyer. Take a loan of $150,000. Interest at 7 per cent means the interest bill alone - without paying off any of the principal - is $10,500 each year. If the interest rate were 5 per cent, the annual interest bill would be only $7,500.
In other words, our foreign debt means that low-income home-buyers have to find an additional $60, after tax, out of their weekly pay-packets just to service the interest payments on their house borrowings.
Now all of this is especially important when we now acknolwedge that, at current interest rates, low-income families are paying 34 per cent of their income (before tax) in house repayments.
Home ownership is rapidly becoming an impossible dream for low-income families. And it may be that many of those already buying homes will be unable to keep servicing the loans.
Try telling all these families that Australia's foreign debt is solely a matter of contract between borrower and lender and has no impact on the economy and the wider community!
Furthermore, of course, the impact of higher interest rates does not end with housing. The two per cent extra we pay is loaded onto everything we buy: because business, too, is hit with the same higher interest charge on its borrowings, which it must load onto its prices.
So the consequences of our foreign debt burden run right through the economy. Moreover, it is getting worse. Sooner or later, we will have to deal with it.Unrestricted imports
Now here comes the really interesting part. Remember how we are always being told of the advantages to consumers, in terms of cheaper goods, by opening up our markets to the unrestricted flow of imports?
The question is this: can that really be true if we add up the cost of what is loaded onto the cost of living by having interest rates two percentage points higher than they would be if we were not borrowing as much as we do?
Perhaps, after all, those cheap imports are costing us more than we think. Maybe we ought to be thinking about the cost/benefits to us of re-establishing our run-down manufacturing industry base and producing more here in Australia of what we currently import. Maybe, on balance, we would be better off if we did.
Now there is something worth thinking about.- Colin Teese is a former deputy secretary of the Department of Trade.