As news is emerging that Australian Treasurer, Josh Frydenberg, will soon deliver a balanced budget for the first time since the GFC, one needs to ask if this is even appropriate today. While surpluses are prudent and allow for protection against future downturns, the logical time to build government surpluses is when growth is strong and interest rates are rising.
But growth is not strong here in Australia today. And it has weakened significantly in China and the EU in recent months. Furthermore, interest rates have collapsed globally.
In Frydenberg’s own words: “My first priority is about implementing our election commitments.” This is fair enough and even a breath of fresh air. But should the environment call for different fiscal settings, our political leadership should be prepared to change course as well.
Now, an Australian Treasurer focused on regaining a federal budget surplus might argue that Australia has not had a recession for 28 years. As such, why shouldn’t any prudent government focus on rebuilding a surplus and paying down debt? While logical at first glance, this period of 28 years with no recession is a fact that is both true and highly misleading at the same time. As pointed out by many economists, including the Federal Reserve Bank of St. Louis as recently as last week, Australia has avoided a “recession” over this period purely through high population growth. But when economic growth “per capita” is analysed instead, Australia has indeed had three recessions over the last 28 years – the most recent one being from the second quarter of 2018 to the first quarter of 2019.
Three years ago, the Australian Treasurer – a man who is now the Prime Minister – promoted the idea of conceptually separating the notion of “good debt” and “bad debt”. The idea was that debt used to fund infrastructure was good; but debt used to fund recurring expenditure was bad. Of course, it didn’t take long until the politics of viewing various forms of government expenditures through the simplistic lens of good versus bad became a headache.
But the general concept wasn’t wrong. Indeed, there is one aspect of this idea that both sides of politics could likely agree on – at least privately. And this is that debt-funded public initiatives which generate social benefits well above the cost of said debt must be value accretive for society. There is no transferring of debt burdens to future generations under such a scenario because the associated social benefits are also transferred to future generations.
Now, measuring social benefits objectively and keeping the politics out of investment allocations is the age-old challenge. But one thing is for sure: the hurdle rate over and above which public investment makes sense has recently become a whole lot lower.
The Australian government can today borrow at a fixed interest rate of less than one percent per annum for 10 years; and less than 1.6 percent for 30 years. These rates are half the level they were one year ago.
So the question we’re all asking is obvious: why is the government not taking advantage of this new low rate environment? When mortgage rates fall, property investors typically rush to take advantage of low borrowing costs. Indeed, this dynamic is currently supporting a resurgence in some of Australia’s major property markets. Should governments not do the same?
And in the words of RBA Governor, Philip Lowe, from just one week ago: while the global economy is still growing, “the risks are increasingly tilted to the downside”. And on the Australian economy? “We are not expecting a return to strong economic growth in the near term…” Perhaps some sensible fiscal stimulus would help.
Andrew Macken is a Portfolio Manager with Montgomery Global Investment Management. To learn more about Montaka, please call +612 7202 0100.
