… It could be a blessing in disguise. That’s the title of a piece I wrote for The Guardian on the news that our rating had been placed on negative watch
The outcome of the election gives little to cheer about: a government elected on a narrow margin, riven with internal divisions, and with little in the way of a coherent plan. But there is one potential blessing in disguise: the likelihood that Australia will lose its AAA credit rating.
The announcement by Standard & Poors that Australia’s AAA credit rating was to be placed on a negative outlook was widely greeted as a harbinger of doom. In reality, however, the loss of the AAA rating would have almost no effect on our economy. More importantly, the central importance placed on the AAA rating by Australia’s political class has seriously distorted our economic policy debate.
Most obviously, the attention paid to the AAA rating reinforces the view, which has dominated Australian policy discussion since the 1980s, that financial markets provide most accurate possible judgements on economic management. This view seemed plausible in the early years of financial deregulation, which followed the crises of the 1970s. But decades of experience since then, included the ‘entrepreneurial’ excesses of the late 1980s, the dotcom boom and bust of the 1990s and above all the Global Financial Crisis have shown that it is false. The judgement of John Maynard Keynes that ‘When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done’ has been shown to be well-founded.
Of all the actors on the financial markets, none have failed more spectacularly than ratings agencies. In the leadup to the GFC, AAA ratings were tossed around like confetti, being awarded to derivative securities that were ultimately based on home mortgages that could not possibly be repaid when prices inevitably fell. Hundreds of these allegedly gold-plated securities went into default. Only when disaster was already obvious did the agencies fix their ratings.
The performance of the agencies with respect to government debt is no better. Agency ratings tell us nothing we don’t already know. For example, after the Brexit vote, it’s obvious that the outlook for the UK economy, and for UK government finances is more questionable than before. The downgrading of the UK credit rating confirms this after the fact, but doesn’t tell us anything that wasn’t already obvious. Clearly the agencies were just as surprised by the Brexit vote as everybody else.
The more serious problem is that the maintenance of a AAA rating requires a policy of holding down debt, even at the cost of forgoing socially beneficial investments.
?Exactly the same logic applies to corporations. The investment policy required to maintain a AAA rating is so conservative as to ensure that many profitable investments are foregone. Only two US corporations (Microsoft and Johnson&Johnson) now maintain AAA ratings on their debt. Microsoft has recently chosen to risk a downgraded by purchasing LinkedIn, a step that makes obvious business sense, but implies a need for more debt. Soon, AAA-rated corporate debt will be nothing but a memory.
The same realization is finally coming to national governments. Only three members of the G20 (Australia, Canada and Germany) now maintain AAA ratings. Germany’s pursuit of the austerity policies needed to maintain a AAA rating has come at a terrible price for Europe, which remains in depression nearly a decade after the GFC.
Advocates of aggressive debt reduction often make an analogy with households, saying that governments, like households, can’t sustain high levels of debt indefinitely. The analogy is problematic because households, unlike governments, have a finite life. More importantly, though, Australian households do not, in reality, behave in anything like the way that this analogy is supposed to support.
Australians use debt as a financial management tool on a large scale. We use credit cards to manage our ordinary income and expenditure from week to week, personal loans to finance the purchase of cars and household durables and of course, mortgages to enable us to buy houses.
The average new mortgage in Australia in 2015 was $371,200, more than 500 per cent of median household income. Moreover, with many loans issued on an interest only basis, these high debt levels are sustained for long periods, often being repaid only when the house is finally sold. By comparison, Australian net government debt is currently around 15 per cent of GDP, or about 60 per cent of the government’s annual income from tax revenue.
There is one reasons we might care about losing our AAA rating. It means that the government will pay a slightly higher rate of interest on bonds issued in the future than it would if we kept the rating and nothing else changed. The margin between AAA and AA+ bonds is typically between 0.2 percentage points. Eventually, when our entire public debt of around $300 billion, that will amount to an extra cost between $600 million and $1 billion per year, if nothing else changes.
Of course, many other things will change. The last time Australia’s credit rating was downgraded, in 1986, the interest rate on government bonds was around 14 per cent. Today, it is below 2 per cent and falling. Whether or not our rating is downgraded, the interest rate will continue to fall along with rates around the world.
The low interest rates we see today will not last forever. But while they do, Australian governments have the opportunity to lock in long-term finance for investments that will benefit both current and future generations. They should not be deterred by the phantom of a AAA rating.