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Where will all the money come from to fund the stimulus?

bigdog

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Where will all the money come from to fund the stimulus?
https://www.theage.com.au/business/...rom-to-fund-the-stimulus-20200403-p54goi.html

Was the money sitting there all along? Who will we have to repay when this is all over? And will we ever get the budget "back into black"?
By Jessica Irvine
April 3, 2020

The Morrison government has unleashed stimulus worth more than $200 billion in a bid to save Australia from a very deep and prolonged coronavirus-induced recession.

Announcing this week's $130-billion wage subsidy for workers, Treasurer Josh Frydenberg justified the spending by declaring: “Extraordinary times call for extraordinary measures.”

But where is all this money coming from? Was it sitting there all along? Who will we have to repay when all this is over? And will we ever get the budget back into black?

How does the federal government get money?
Understanding what is about to happen to the government's budget requires a basic knowledge of a few things.

The federal government has a commitment, over the long run, to balance incoming money from tax collections with outgoing spending on welfare, health services etc.

When the government raises more revenue than it spends in a year - for example because a mining boom has turbocharged company tax collections - its budget is said to be in surplus. These surplus funds can then be used to pay down any existing debt.

When the Morrison government boasted of getting the budget "back into black", it only ever meant that it was going to start running annual budget surpluses – not that it had eliminated debt altogether.

In fact, Australian governments have never completely paid off debts accumulated in previous downturns and crises, according to Deloitte Access Economic's Chris Richardson. It's just that economic growth has been so rapid as to dwarf the size of the debt relative to our national income.

"We have always had debt," says Richardson.

Debt is incurred when government spends more money than it raises in a year – either because revenue has fallen short or spending demands have risen, or both – and the budget falls into deficit. In order to be able to keep paying its regular incoming bills – such as public service wages – the government must borrow to fund any shortfall, adding to any existing pile of debt.

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How much debt is the government already in?
Prior to the global financial crisis, the Howard government had managed to reduce Australia's net debt to effectively zero, thanks to the mining boom.

After a decade of running big deficits, however, Australian government debt today is, in dollar terms, higher than at any other time in history.

As a percentage of our economy, however, net debt is about where it was in the mid-1990s in the aftermath of the early '90s recession.

upload_2020-4-6_14-12-5.png

Last financial year, Australian government net debt stood at $373 billion or 19.2 per cent of gross domestic product.

This compares favourably to other nations. Both the United Kingdom and the United States carry net government debt worth about 80 per cent of their economies.

At the time of the last budget, the Australian government was forecasting it would achieve a budget surplus this financial year and use the surplus funds to pay down net debt to $360 billion, or 18 per cent of GDP.

Now, however, net debt can be expected to top half a trillion dollars

How does the government borrow?
On level three of the Treasury building in Canberra's parliamentary triangle, sits a group of people known as the Australian Office of Financial Management (AOFM).

These people are the government's debt managers. Essentially, they act as intermediaries between the government and its potential lenders.

Every couple of days, depending on requirements, they set up online auctions for things called government bonds. These bonds are essentially government promises to repay borrowed money, plus interest, to investors. Investors lodge bids to buy these bonds by indicating what interest rate they will accept, and it's all over in minutes.

As of April 3, the AOFM had $579.2 billion of these bonds on issue to investors. We call this the level of Australia's gross debt, with net debt figures much lower, reflecting the offsetting value of various assets also held by the government.

In order to fund the stimulus package, the Australian government will simply instruct the AOFM to conduct more frequent and larger auctions of these bonds. As a result, the level of outstanding government debt will go up and so too will the total interest bill that must be paid out.

Who does the government owe money to?
So who buys these bonds? According to the AOFM, just over half of Australian government bonds are held by non-residents. These include foreign banks, central banks and investors, including big pension funds.

Even during a crisis, big global pension funds continue to receive a steady stream of contributions from workers and they need somewhere to park the money.

The remainder is held by Australian entities, including banks, super funds and other institutional investors.

The Reserve Bank has also started to purchase Australian government bonds. It is seeking to keep interest rates low by adding to demand for such bonds.

The Reserve has said it will not buy bond directly at the AOFM auctions, to avoid crowding out other lenders, but will instead pick them up in the secondary market.

Ultimately, however, we can expect the central bank to become a bigger owner of Australian government bonds.

How much does it cost the government to borrow money?
The good news is that debt is very cheap at the moment because interest rates are low.

It has been observed that the world has a savings glut of money looking for attractive investment returns, of which, given increased risk aversion in the post-GFC era, there have not been a lot. So far, AOFM auctions for Australian government bonds have tended to be oversubscribed.

So, while the value of Australian government debt in dollar terms is historically high, the interest bill on that debt as a proportion of the broader economy is not.

The government paid $14 billion in net interest payments on its borrowings last financial year.

upload_2020-4-6_14-13-56.png

But as a per cent of GDP, net interest payments were just 0.7 per cent of GDP, compared to 1.7 per cent in the aftermath of the early 1980s and early 1990s recessions.

With interest rates as low as they can go, however, and debt set to soar, that interest bill will rise.

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How will we pay the money back?
Slowly, over time.

When the virus has run its course, and particularly if the stimulus has been successful in protecting jobs, we can expect spending needs to subside and economic activity to lift, producing more tax revenue.

When we start to run budget surpluses again, we can start to pay down the accumulated debt. This may take a very long time.

But it is not impossible. The mining boom of the 2000s helped the Howard government restore the budget to balance after the 1990s recession.

Will our grandchildren pay the price?
Chris Richardson is keen to dispel the idea that borrowing today will impose an unfair burden on future generations.

With interests rate so low, the interest bill on the additional $213 billion of borrowings will be just $1.6 billion a year.

"That’s not nothing," says Richardson. "You’d much prefer not to have to pay that much extra in interest every year ... Yet these costs are far from scary."

Were, however, the government to fail to act to counteract this economic crisis, Richardson fears the budget – and nation – could end up in a much worse state, as joblessness soars, revenue plummets and welfare costs soar.

Richardson says Australia must now be on a war footing: "Australia’s economy will grow again on the other side of this war. So, here’s a simple suggestion: let’s just let our debts from this new war simply become a smaller share of our growing economy over time. That’s what we did with the war-time debts of the past. And it’s probably the smart play this time too."

"There are lots of things to be scared of," concludes Richardson. "The fight for our health is a long way from being won. But don’t be scared of the debt – its costs aren’t that bad. And chances are that taking on this debt will be a great investment in Australian livelihoods."
 
Thanks for posting the story. Very informative.

I wonder what would happen if the Reserve Bank continues to buy Government bonds and than, at some stage in the future, simply writes them off ? That part of Govt debt "disappears ".:cautious:
Thoughts ?
 
Thanks for posting the story. Very informative.

I wonder what would happen if the Reserve Bank continues to buy Government bonds and than, at some stage in the future, simply writes them off ? That part of Govt debt "disappears ".:cautious:
Thoughts ?
I would think there are some very big wheels turning, to work out a way to write off this QE debt, that has been going on for the past 10 years or so.
Also at the same time, an answer to the upsurge in the cryptocurrency alternative monetary system, will probably have to be incorporated.
 
They don't need to write off debts, they can just acquire them and let them mature.

What they don't realise is they are really doing the opposite of what they should be doing.

QE, they are buying up Gov securities, i.e. taking them off the market and stuffing the banks full of "bank reserves".

But those Gov securities are used by the financial system as "pristine collateral" in repo trades. So the QE is actually removing collateral used by the modern financial system to function properly, and replacing with bank reserves that are not used by the financial system at all.

Clueless.

They should just do the exact opposite! A lot more deficit spending, issue many more Gov securities, no QE, flood the system with collateral.
 
They don't need to write off debts, they can just acquire them and let them mature.

What they don't realise is they are really doing the opposite of what they should be doing.

QE, they are buying up Gov securities, i.e. taking them off the market and stuffing the banks full of "bank reserves".

But those Gov securities are used by the financial system as "pristine collateral" in repo trades. So the QE is actually removing collateral used by the modern financial system to function properly, and replacing with bank reserves that are not used by the financial system at all.

Clueless.

They should just do the exact opposite! A lot more deficit spending, issue many more Gov securities, no QE, flood the system with collateral.
We have a sovereign fiat currency, so we can print as much money as we like to stimulate our internal economy.
Fiat currency is simply government debt.
Governments never began with the capacity to generate an income external to the economy, so the money they print is part of a sophisticated accounting exercise that hides real debt.
A great site to review this for the USA is here. Note the numbers at "currency and credit derivatives."
 
LOL - gotta bookmark this thread and come back in 10 years for another LOL

The reality is if the welfare state Australian economy functions post CV-019 as it did prior it simply won't have the capacity to service a $14b yearly interest bill - let alone mitigate the debt.

When the Govt has finished handing all this money out, watch what happens when they try to make us pay it all back + interest...

We'll be changing Prime Ministers every 6 months :)
 
How the Reserve Bank creates $30billion in a second
Excellent explainer of the current processors used by the bank to inject liquidity into the markets and keep interest rates low.

As part of its coronavirus response, the RBA is creating money out of thin air. Here's how
https://www.abc.net.au/news/2020-04-07/coronavirus-economy-printing-money/12125816
Thanks for the more simpler explanation for mere mortals like me :xyxthumbs

I was lost with some of the previous posts by other fellow posters :confused:
 
How the Reserve Bank creates $30billion in a second
Excellent explainer of the current processors used by the bank to inject liquidity into the markets and keep interest rates low.

As part of its coronavirus response, the RBA is creating money out of thin air. Here's how
https://www.abc.net.au/news/2020-04-07/coronavirus-economy-printing-money/12125816

Shame it is wrong.

But now the Reserve Bank is creating money out of thin air instead.

No it is creating bank reserves out of thin air: bank reserves are not money.

They even say it themselves

In a statement to the ABC, the Reserve Bank said:

"Asset purchases — also known as quantitative easing (QE) — involves the outright purchase of assets by the central bank from the private sector with the central bank paying for these assets by creating 'central bank reserves'.

"This has been popularly referred to as 'printing money'."

Even they know it is not printing money.

They are completely powerless, it's just perception management, they want you to think they are printing money because that is the only thing they can influence. Perceptions. And the ABC just plays along without any critical thinking that you'd hope for from a finance journalist.

This is wrong too:
As the Reserve Bank buys up government bonds their price goes up and the yield, or interest rate, on those bonds goes down.

Again, even the RBA says, they are just HOPING
The Reserve Bank has said it is targeting three-year bonds in the hope of lowering the entire regime. But it has said it will buy across the spectrum of bonds too.

They can't even control their own cash rate, how can they control the bond market
Reserve Bank representatives literally buy and sell securities at the bank's headquarters in Martin Place on a daily basis to ensure the cash rate, or overnight money rate, sits at roughly 0.25 percentage points (where the cash rate currently stands).

But HSBC has told the ABC that on several days in the past few weeks, the cash rate has actually dropped much lower than that.
 
Difficult to understand the inter-relationships of the Big Bank and it's banklings. I think the gist of what is said is the reserves are topped up right? So is it correct to say they look after themselves quite well, and banks will not be allowed to go under as long as Big Mama is in control ?

I also understand when they are talking about ASSET purchases, they are really talking about DEBT purchases. This is a crucial piece of the puzzle to understand, because bank assets are actually debt that they own whether it's public, private or company/corporate debt.

Is there any flow on effects to the real economy in terms of money supply ?
 
That's what I thought, makes sense :cool:

Actually, let me re-phrase!

There is an impact on the money supply.

By buying Gov securities, the RBA is reducing the total amount of pristine collateral in the system available for repo transactions.

Repo being one of the corner stones of the modern financial system, they are reducing the money supply by reducing the available collateral for repo transactions to occur on bank balance sheets.
 
Actually, let me re-phrase!

There is an impact on the money supply.

By buying Gov securities, the RBA is reducing the total amount of pristine collateral in the system available for repo transactions.

Repo being one of the corner stones of the modern financial system, they are reducing the money supply by reducing the available collateral for repo transactions to occur on bank balance sheets.
Could you please explain what is the Repo transactions and why it's so important for people like me ?
 
The repo market is a short term funding market.

Someone who owns an asset, like a bond, can put it up (as collateral) in a repo transaction and get cash in return from a lender, then at a specified future date they will re-purchase (repo) the asset and return the cash + some interest (repo rate).

Imagine you are a bank.

You have a bunch of assets, like corp bonds, mortgages securities, etc.

You fund these assets in the repo market. Every day you put a bunch of assets as collateral into repo transactions and other banks or financial instos who have spare balance sheet capacity will give you cash funding in return for a bit of interest that you will pay back when you repurchase. No problem, you can do this every day, the repo rate is much lower than the rate you're getting on your corp bonds or RMBS or whatever.

One day, something bad happens. Maybe a global virus pandemic or maybe currency spike or whatever.

Now, you go to the repo market and put up your collateral, and the guy on the other side of your transaction says this collateral is not so good in the current situation. I need you to put up more collateral to get the same funding.

What do you do? You need to go find some fresh collateral. What is the best collateral that will never get a haircut in a repo? Gov securities.

If there is no collateral to be had, or the price is too high, you will need to sell whichever assets you can't fund.
 
The repo market is a short term funding market.

Someone who owns an asset, like a bond, can put it up (as collateral) in a repo transaction and get cash in return from a lender, then at a specified future date they will re-purchase (repo) the asset and return the cash + some interest (repo rate).

Imagine you are a bank.

You have a bunch of assets, like corp bonds, mortgages securities, etc.

You fund these assets in the repo market. Every day you put a bunch of assets as collateral into repo transactions and other banks or financial instos who have spare balance sheet capacity will give you cash funding in return for a bit of interest that you will pay back when you repurchase. No problem, you can do this every day, the repo rate is much lower than the rate you're getting on your corp bonds or RMBS or whatever.

One day, something bad happens. Maybe a global virus pandemic or maybe currency spike or whatever.

Now, you go to the repo market and put up your collateral, and the guy on the other side of your transaction says this collateral is not so good in the current situation. I need you to put up more collateral to get the same funding.

What do you do? You need to go find some fresh collateral. What is the best collateral that will never get a haircut in a repo? Gov securities.

If there is no collateral to be had, or the price is too high, you will need to sell whichever assets you can't fund.
Very good explanation, thanks. I think this reminds me of similar discussion around the GFC time.

All was fine while the banks could sell or lend their sub-prime mortgage debt bombs (named as Collateralised Debt Obligations or CDO's) around to each other while everything was powering along.

But as soon as one bank goes bankrupt no financial institution wants to touch them with a bargepole. So they had to come up with 'AAA' type bonds as collateral for any funding requirements.
upload_2020-4-7_16-48-10.png
 
Very good explanation, thanks. I think this reminds me of similar discussion around the GFC time.

All was fine while the banks could sell or lend their sub-prime mortgage debt bombs (named as Collateralised Debt Obligations or CDO's) around to each other while everything was powering along.

But as soon as one bank goes bankrupt no financial institution wants to touch them with a bargepole. So they had to come up with 'AAA' type bonds as collateral for any funding requirements.
View attachment 102064
Especially when the CDO's were actually made up of junk mortgages.

Good write up by you and investoboy, excellent extraction of the detail.

I guess we are lucky that we are late to the table, with the QE, most have been at it for 10 years.
 
On Thursday, S&P highlighted that “the cost of the JobKeeper program ... has been materially lower than originally budgeted in March” and that Frydenberg’s “economic and fiscal update [was] consistent with the [nation's] 'AAA' rating”.

The performance of Australia’s current account surplus, iron ore prices, labour market, and the housing market have all been upside surprises for the rating agency and most analysts.
 
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