Losing our AAA credit rating is not a harbinger of doom …

… 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.

64 thoughts on “Losing our AAA credit rating is not a harbinger of doom …

  1. @Ikonoclast

    No, I don’t argue for adjustments within the system. I argue that macro-economic models (Classical, Neo-classical, Keynesian, MMT) are at best mis-used and at worst they are useless because they do not adquately (even on the conceptual level) model any economic system.

    For example, you state conditions found in Piketty regarding the relationship between the growth rate (of GDP) and the rate of return (on ‘capital’) and you relate it to growth in wealth inequality. I agree. Here a macro-economic relationship (the two growth rates and implications for wealth distribution) are, IMHO, a very important diagnostic tool. But, having a diagnostic tool isn’t sufficient. One then has to come up with policy measures to solve the problem. I am saying debt driven growth of GDP isn’t necessarily the best solution. It depends.

  2. @Ernestine Gross

    Everything always “depends”, Ernestine; that isn’t the question. The question is, as always, what, when, where, why, who and how.

    Would you be able to ‘refudiate’, or at least seriously critique, Krugman’s use of the IS-LM model ? He argues that, contrary to your assertion about “do not adequately […] model any economic system” that it very adequately modelled the USA, and much of the world’s, economic system during and after The Great Recession.

    Or at least that’s what I sincerely think he’s been saying.

  3. @GrueBleen

    Recently I listened to a streamed lecture series by Steve Keen. Steve was an examiner of a PhD thesis I supervised. He surely was the right choice. I was delighted to hear Steve talk about the reality of how ‘money and finance’ work. He is gifted with words. In the past I had a bone to pick with Steve because of his criticism of ‘neo-classical economics’. In the lecture series he made it clear what he meant, namely micro-economics which never deals with ‘the aggregate’ at the same time (in contrast to agent models under alternative assumptions about the institutional environment).

    So, as to the apparent contradition of policy advice, I say it is an artifact due to the implied assumption that conditions are the same all over the world.

  4. @Ernestine Gross

    I hate to admit it but I agree with GrueBleen here and only here:

    It is not good enough to say,

    I am saying debt driven growth of GDP isn’t necessarily the best solution. It depends.

    The Bank for International Settlements’ Claudio Borio is saying the same.

    If you have capitalism – you must find some means to fight off its crisis tendencies, and debt is one of these.

    Growth under capitalism can “depend” on debt.

  5. Ivor
    Debt fueled growth is THE essence of capitalism. There is no other kind of growth in capitalism.
    Either the government debt or private debt has to fuel additional money in circulation. If banks stop doing it to private sector.

    Why there is a neccesity for additional money into the system?
    Savings take money out of circulation.

    So, even without population growth that requiers larger amount of money or higher velocity, savings drain liquidity out by being kept into banking accounts and then transfered as reserve to Central bank, such is the law of most banking systems in world.

    Savings are permanently put in reserve at CB by law, only governments can borrow that and return it into circulation. That is called government deficit, or accumulated public debt.

    Government debt is private savings returned into circulation.

    Since savers in agregat keep saving more and more, governments never have to return/pay off their debts.

  6. Why Steve Keen was right that just a slow down in debt growth will cause recession?

    If government does not go into debt and returns savings back into circulation, then growth of private debt has to.

    As banks create money by credit and put it into circulation, paying off the debt is destroying that money out of circulation.

    Since recent decades show growth of profit/ savings, it says that there was accelerated size of money taken out of circulation. Only the new credit can replace it if government doesn’t with deficit. Growth of profits/savings/ inequality is causing lack of liquidity in the system. This forces unemployment/less circulation given unchanged velocity. But velocity also slows adding to problems. Without government going into higher debt to refill liquidity it can spiral out to unescapable depression.

    This view clearly leads to Marxist point of view which is why wealthy prevented discussing about money, banks and debt among economists and especially among jurnalists.

  7. Even Pikkety stays within mainstream economics and doesn’t discuss debt as main part of inequality and lowering g while r barelly lower. He doesn’t mention the money and debt, but class power relations.

    The reason for falling demand is the price of debt to poorer agents against price of debt for wealthier, more powerfull, people, corps or states.

    Institutional set up of cradit rating agencies automaticaly makes poorer pay more for credit.
    Credit rating agencies give better rating to those that already have wealth which lowers their burden of debt by lowering the price/interest rate for credits.

    How? Having assets/wealth gives you more points which lowers the interest rate.
    By changing those institutions so that having assets takes away points and with it raises interest rates wealthy pay for credits, forces that contribute to inequality would be weaker.

    This matters to states that owe in foreign currencies and their CB governors follow orders from their creditors instead of debtors. Those states that owe only in their own currency have much less problems to deal with. Their CB governors can easilly control monetary policy.

    I have spent last year searching for a solution to debt in foreign currencies and foreign control of state debt and i believe i have it now.
    I have found out how banks can print foreign currency, not only domestic one.

    Another institution that raises inequality, besides credit rating agencies as a main one, is government debt. It incentivizes investing into paper assets instead of real capital production. Over long time it will make investments into paper assets more profitable then real investments. How?

    Savings are forced into bank reserves and then borrowed by government to put it back into circulation. But, over time, since many people keep saving more and more without ever spending their savings and those savings incurr income, there is a self enlarging part of savings that keeps circulating between more savings and government paying more interest on interest on interest on interest that paid it before. “”””It becomes ever enlarging self perpetuiting cirlce separated from economy.”””””””Only thing it does is enlarging government debt while those savers never spend such incomes that keeps growing.
    This becomes the safest and easiest income to large savers which incentivizes them to abandon capital investments and invest ever more in paper aassets.

    two ways that inequality is increasing is
    i) by credit rating scoring so that poor pay more in interest proportionaly to income and debt in contrast to wealthy
    ii) government debt over time makes investment in paper assets more profitable then in real capital investment.

  8. @GrueBleen
    “But Australia does, Jordan, Australia does.”

    YOu should ask australian states how their debt is doing. Please check it out. As far as i know, federal budget is reducing expenditures and giving bills to states instead. Over time much more it got to be states responsibility while federal gov is paying of debts.
    They really cheated you into believing that fed gov can reduce its debt without causing unemployment after iliquidity. HA HA HA HA HA

    When you learn accounting you will learn that it is impossible for government to reduce its debt due to accounting rules and needs of the real world.

    Just not to confuse you again we should call it consolidated government. But how precise we have to be? untill you do not understand words anymore?

    In acctuality, consolidated government should include banks, and comercial banks. But now we are going too technical which is going to confuse you even more. But, QE shows that banks should be part of consolidated government against private sector for the purpose of economic calculations and predictability. But that is even more technical for you since you have not studied accounting and banks, or money and debts in agregate play.

  9. @Ivor

    That’s very decent of you, Ivor. And in that case I might just explain Edmund Burke to you one of these days. In the meantime, you might like to contemplate this:

    “I disapprove of what you say, but I will defend to the death your right to say it.”

  10. @GrueBleen
    I must have hit the right spot considering your reactio.

    How many minutes of your life did you use to study bank and state accounting?
    Probably not a single one, right? Yet you would tell me that i am wrong about banks and states which i studied for couple of years and reading laws about banking from few countries.
    What is such behaviour like yours called? Hipocrisy? Dogma? Ignorance?

  11. I know that prof. J.Q. did couple of post abut federal aus government placing more burden on individual states by shifting spending while keeping the same income. This is how federal gov could reduce debt while placing the burden on states, forcing them to take on more debt just to keep the level of service on par.
    Nice trick, but it can work only for some time.

    And then states are forced to do much more public-private-partnerships just to hide levels of debt under PPP corporations. It is all trickery just to allow lovering taxes on the wealthy.

  12. @Jordan from Croatia

    No, no Jordan, try as you might to make matters worse, you’ve already stated all that you possibly can.

    But if you keep procrastinating like this, there won’t be any good lives left anywhere that you could aspire to live.

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