Thursday, July 30, 2020

The government has just sold $15 billion of 31-year bonds. What's a bond?

There are the Boxing Day sales, and there was this week’s rush of extremely cashed-up investors desperate to get a slice of this week’s rare 31-year government bond auction.

What’s a bond? What’s a bond auction? We’ll get to those shortly.

First, just know that the government received A$36.8 billion of bids, $20 billion of them within hours of opening the two-day auction on Monday.

It had been wanting to move $15 billion, and could have moved that much again.

$15 billion makes it the third biggest bond sale in Australian history. The two bigger were recent – a $19 billion ten-year bond sale in May and a $17 billion five-year bond sale in July.

Each sale nets the government money it won’t have to pay back for five, ten or 31 years at rates of interest that until recently would have been unthinkably low.


Read more: More than a rate cut: behind the Reserve Bank's three point plan


The 31-year bond went for 1.94%. That means the foreign and Australian investors who bought them (including Australian super funds) were prepared to accept less than the usual rate of inflation right through until 2051 in return for regular government-guaranteed interest cheques.

Investors who bought ten year bonds were prepared to accept only 0.92% per year, investors who bought five year bonds, only 0.40%.

What’s a bond?

Even bond traders find it hard to get a handle on what bonds are. In his novel Bombardiers, author Po Bronson writes a scene where a bond trader refuses to work any more and demands to see an actual bond, “any kind of bond”.

He tells his boss he can’t sell bonds “if he’s never seen one”.

Like many things that used to exist physically, they’re now mainly numbers on screens, but it helps to get a picture.

This one is a US 27-year bond from 1945.

The Joe I. Herbstman Memorial Collection

The biggest part of the paper is a promise to repay the US$1000 it cost, in 27 years time.

The smaller rectangles are called coupons, and each year the owner can tear one off and take it in to get 2.5%.

If the owner wants to sell the bond to someone else (and bonds are traded all the time) it’ll be sold with one coupon missing after one year, two coupons missing after two years, and so on.

When rates fall, prices rise

The price of a bond will vary with what’s happening to interest rates. If they are falling, an existing bond, offering returns at old rates, will become more expensive and can be sold at a profit. If they go up, an existing bond will become worth less and have to be sold at a loss.

It leads to confusion. When bond rates fall, bond prices rise, and visa versa.


Read more: 'Yield curve control': the Reserve Bank's plan for when cash rate cuts no longer work


For half a decade now bond rates have been falling. They’ve fallen further during the COVID crisis, making bonds a doubly good investment. They offer superannuation funds and others certainty at a time when everything seems uncertain, and if rates continue to fall they increase in value.

It is an indictment of our times that so many investors want them. The government’s office of financial management is going to need to sell an extra $167 billion over the coming year. The rush to buy suggests it could sell more.The Conversation

Peter Martin, Visiting Fellow, Crawford School of Public Policy, Australian National University

This article is republished from The Conversation under a Creative Commons license. Read the original article.

Read more >>

Thursday, July 23, 2020

These budget numbers are shocking, and there are worse ones in store

Even if the government hadn’t spent A$5.9 billion on JobKeeper and other emergency measures last financial year and wasn’t planning to spend a further $12.2 billion this financial year, its budget position would have collapsed.

The economic statement released Thursday morning shows it collected $13.2 billion less company tax than it expected last financial year, and will collect $12.1 billion less this financial year.

It collected $9.2 billion less personal income tax last financial year and will collect $26.9 billion less this financial year.

That’s assuming the present lockdown in Melbourne, the Mornington Peninsula and the Mitchell Shire lasts only six-weeks followed by a gradual return to normal and no further lockdowns.

Reality bites

Goods and services tax and excise and customs duty collections are down by $7.3 billion last financial year and down by a forecast $10.7 billion this financial year.

Tax collections from super funds held up in the financial year just ended but are expected to halve in 2020-21, collapsing from $13.2 billion to $6.4 billion.

The collapse reflects what Treasurer Josh Frydenberg called “the reality of where the economy is at”.

Business are closed, planned investment has been axed (non-mining business investment is expected to fall 19.5% this financial year after falling 9% last financial year), consumers are staying at home, and spending on housing is expected to fall 16% after falling 10%.

It has to be lived with

Most of this can’t be undone. Nor can it be offset by increasing tax rates or cutting government spending. As Finance Minister Mathias Cormann noted, that would shrink private spending further.

Net government debt, which was expected to be close to zero last financial year (0.4% of GDP) instead blew out to 24.6% of GDP and is expected to blow out to 35.7% this financial year.

The only safe way to bring it down is to ramp it up as much as is needed to ensure the economy recovers.

As Cormann put it,

the way to get on top of this debt is by growing the economy more strongly and creating more opportunity for Australians to get ahead, get into jobs, better paying jobs and get ahead, because stronger growth leads to more revenue and lower welfare payments and that is the way that we can go back to where we were

It has worked before. Australian government debt blew out to more than 100% of GDP during the second world war but then shrunk year by year in relation to GDP in the economic growth that followed.

Debt didn’t shrink in absolute terms, it shrank in relation to the government’s ability to handle it, and that’s what will happen again if economic growth can be reignited.

The government has been borrowing at annual interest rates of less than 1%. If the economy can grow by more than 1% per year, which historically it has, the payments will eat into less and less of the budget.

Finances are holding up

Next week the government’s office of financial management launches an audacious bid to lock in ultra-low borrowing rates until the middle of the century.

It will issue an unusually long-dated bond (lone) lasting 31 years. It won’t need to be repaid until 2051.

It has appointed five lead managers to sell it – ANZ, Commonwealth Bank, Deutsche Bank, JP Morgan Securities and UBS – in the hope that it can bed down low annual interest payments for a generation.

In the unlikely event the market doesn’t support it, the Reserve Bank has undertaken to step in and use created money to buy as many bonds as are needed to keep the rates low. Since it made the commitment in March it hasn’t needed to spend much at all. Government bond issues have been up to five times oversubscribed by investors desperate for the certainty of a government revenue stream and uneasy about riskier alternatives.

Best case

The forecasts for what will be required need to be seen as best case. The budget deficit is believed to have blown out from an expectation of around zero to $85.8 billion in 2019-20 and $184.5 billion in 2020-21.

Those forecasts have the unemployment rate at 8.75% by this time next year, by which time the economy will have shrunk 2.5%

Economic activity slipped 0.3% in the March quarter, is believed to have shrank 7% in the June quarter, is expected to climb back 1.5% in the September quarter and to claw its way back after that.


Read more: Budget deficit to hit $184.5B this financial year, unemployment to peak at 9.25% in December: economic statement


That’s if restrictions aren’t reimposed, state borders are reopened and there are no further “second waves” of infections.

The treasury says its estimates take into account the effect of the Melbourne outbreak on consumer confidence and activity in the rest of Australia, but assume the outbreak does not spread.

In this way the numbers are a best case. The section in the document on risks to the outlook was unusually short – only three paragraphs.

It says the pandemic is still evolving and the outlook remains highly uncertain.

It will present a fuller assessment of the risks and four years of projections in the formal budget on October 6.The Conversation

Peter Martin, Visiting Fellow, Crawford School of Public Policy, Australian National University

This article is republished from The Conversation under a Creative Commons license. Read the original article.

Read more >>

Wednesday, July 22, 2020

Should the government keep running up debt to get us out of the crisis? Overwhelmingly, economists say yes

Overwhelmingly, the 50 leading Australian economists surveyed by the Economic Society of Australia and The Conversation ahead of Thursday’s economic statement want the government to keep spending to support the economy — even if it means a substantial increase in debt.

The question is the third asked in the Economic Society-Conversation monthly poll, which builds on a series of polls conducted by the society since 2015.

The economists polled were selected for their preeminence in the fields of microeconomics, macroeconomics, economic modelling and public policy. Among them are former and current government advisers and a former and current member of the Reserve Bank board.

Each was asked whether they agreed, disagreed, or strongly agreed or strongly disagreed with this proposition:

Governments should provide ongoing fiscal support to boost aggregate demand during the economic crisis and recovery, even if it means a substantial increase in public debt

Only three of the 50 economists polled disagreed with the proposition, none of them “strongly”.

It is one of the starkest results in the survey’s five-year history.

50 economists respond: Govs should provide ongoing fiscal support to boost aggregate demand during the economic crisis and recovery, even if it means a substantial increase in public debt. Strongly agree: 66%,  Agree: 22%, Uncertain: 6%, Disagree: 6%
The Conversation, CC BY-ND

Of the 50 economists polled, 44 supported the proposition, 33 of them “strongly”.

Of the remaining six, three were uncertain, and provided well-argued accounts of their reasoning which are published in full along the responses of each of the other participants at the bottom of of this article.

Debt now, concern later

Rachel Ong of Curtin University said the amount of public debt that has accumulated during the COVID-19 crisis was at a historical high and had to be repaid at some point. But she said governments had to be careful about removing support until the economy was clearly on a trajectory of recovery.

Nigel Stapledon of the University of NSW said while some level of on-going support was needed, at some point the cost would be larger than the benefit. Some sectors, including universities, will have to permanently adjust to lower incomes.


Read more: Bowing out gracefully: how they'll wind down and better target JobKeeper


The economists who strongly agreed said that if not enough support was provided or if it was withdrawn too early, the resulting recession would itself make the debt that had been run up less sustainable (Fabrizio Carmignani, Griffith Business).

Financial markets are keen to lend

Beth Webster of Swinburne University argued the only real limit to government spending was high and damaging inflation.

If the government was worried about debt, it could finance its spending in other ways, by borrowing from the Reserve Bank (which could itself create money and “monetise” the debt).

Sue Richardson from the University of Adelaide agreed, using a technical term to argue that the was economy was “so far inside its production possibility frontier” (producing so much less than it was capable of) and inflation was so dormant, that there was a case for creating money.

Saul Eslake said that wasn’t necessary. Even with the hundreds of billions committed, financial markets appeared to be comfortable with the debt and keen to lend.

Debt is how we do things

Reserve Bank board member Ian Harper said the Commonwealth could borrow for 30 years at about 1%. “Can we expect the economy to grow faster than 1% per annum in nominal terms over a 30-year horizon?” he asked rhetorically. “I would have thought that’s a shoo-in,” he answered. If so, then the debt would be easily serviced.

Consulting economist Rana Roy pointed out that public debt was “not an anomaly”. It was an enduring and defining feature of the modern economy, providing an enduring and defining asset class, sovereign bonds, which were in high demand.


Read more: Australia's first service sector recession will be unlike those that have gone before it


Of the three economists who opposed the proposition, Tony Makin of Griffith supported “supply side” measures such as JobKeeper that would keep firms in business but opposed “demand side” measures to boost consumer spending, saying they would ultimately prove counterproductive.

Escalating public debt would induce capital inflow, drive up the dollar and make Australian businesses less competitive. Although interest rates are at present low, they would increase when the debt had to be refinanced.

Doubts for differing reasons

Paul Fritjers of the London School of Economics said he would normally support running up government debt for the sake of the economy, but could not support it being run up to support an economy the government itself had run down.

The government should wean the population off of its “irrational fears” and letting “normal economic life return”.

Although strongly argued, these views were more weakly held than those of the majority.

Previous responses weighted by confidence: Strongly agree: 70.4%,  Agree: 21.7%,  Uncertain: 3.5%,  Disagree: 4.4%
The Conversation, CC BY-ND

Participants were asked to rate the confidence with which they held their opinions on a scale of 1 to 10.

When adjusted for these ratings, the proportion prepared to countenance a substantial increase in public debt climbed from 88% to 92.1%.

The proportion opposing it fell from 6% to 4.6%.

Tommorrow’s economic statement will be the last budget and economic update before the budget itself on October 6.


Individual responses

The Conversation

Peter Martin, Visiting Fellow, Crawford School of Public Policy, Australian National University

This article is republished from The Conversation under a Creative Commons license. Read the original article.

Read more >>