Sunday, 15 June 2014

Tear up public debt?

Referring to this article The French are right: tear up public debt – most of it is illegitimate anyway
“Debt, rather than popular will, is the governing principle of our societies, through the devastating austerity policies implemented in the name of debt reduction.” 

Austerity measures were widely implemented in Europe as one of the measures to reduce high debt to GDP ratios of many European economies. There are basically two ways of reducing the debt to GDP ratio, either via reducing the nominator (debt) or increasing the denominator (GDP). 

Economists are at loggerheads whether highly indebted countries should pursue growth-friendly policies (which will increase GDP) or austerity measures (which will directly reduce government spending, and thus cutting fiscal deficit). 

Many are against austerity measures, as cutting government spending has entailed massive layoffs for public servants and welfare benefit cuts. Little wonder that unemployment rate in Eurozone remained close to its all-time-high of 12% since late 2012 until now. 

Countries like Spain and Greece were even worst hit, as their joblessness rates now hover around 25%. In my opinion, the painful economic recession in Europe was mainly caused by the uncompromising push to cut government spending. Was it because of high debt? Nope, not necessarily. 

Japan has the highest debt to GDP ratio of more than 200% yet its unemployment rate remains very low at about 3%. 
“French public spending has in fact decreased by two GDP points. What, then, explains the rise in public debt? First, a fall in the tax revenues of the state. Massive tax reductions for the wealthy and big corporations have been carried out since 1980” 
From 1978 to 2012, France real GDP had increased from $500.1 billion to $2612 billion. If public spending had decreased by two GDP points, what does it mean? I don’t have the data for government expenditure but say in 1978, public spending was 50% of GDP and in 2012 it was 48% of GDP. 

Despite a decrease by two percentage points, in absolute terms the government spending had in fact increased from $250.05 billion to $1253.76 billion. According to OECD in 1978, France's tax revenue was 37.3% of GDP while in 2012, it was 45.3% to GDP. Declining tax for the wealthy and big corporations? Rubbish! 

While corporate tax rate had declined from around 42% in 1998 to 33% in 2012, firms have been paying higher taxes in absolute amount to the government. I don’t know where the author got his number for declining France’s tax revenues. 
“The second factor is the increase in interest rates, especially in the 1990s. This increase favoured creditors and speculators, to the detriment of debtors. Instead of borrowing on financial markets at prohibitive interest rates, had the state financed itself by appealing to household savings and banks, and borrowed at historically normal rates, the public debt would be inferior to current levels by 29 GDP points.”
Had the state financed itself from households savings and banks? Good Lord, the writer really needs to learn the economics behind government finances. Government and private sector are two totally different economic animals! Individuals may raise money from bank loans, while companies gather funds from issuing stocks, selling bonds or borrowing from banks.

The government on the other hand CANNOT borrow money from banks/individuals nor issuing stocks. The source of government finance may only come from its tax revenue, or its dividend giving companies (eg Petronas). If a government's expenditure exceeds its revenue, there is only ONE way for it to finance it, ie via issuing government bonds.
A stunning finding of the report is that no one actually knows who holds the French debt.
Dear Mr Keucheyan, do you really think anybody would buy something to the tune of trillion dollars without a legal proof that they own it?
An illegitimate debt is one that grew in the service of private interests, and not the wellbeing of the people. Therefore the French people have a right to demand a moratorium on the payment of the debt, and the cancellation of at least part of it. There is precedent for this: in 2008 Ecuador declared 70% of its debt illegitimate.
A borrower's reputation and credit worthiness is paramount in the eyes of creditors. A country can always decide to default on some or all of its debts, but at least in the short term (few years) it will find it very hard to borrow in international bond markets. Besides, government debt is deemed as the safest security issued in the currency. Eg, U.S. government securities are deemed the safest securities denominated in U.S. dollar.

Government bond is the benchmark security in its currency and it will fetch the lowest interest rate as a government cannot default (most of the time). The interest rate for government bond will be a benchmark interest rate for all other bonds issued in the same currency. A healthy government bond market is a pre-condition for a well-run private bond market.

Should investors doubt the government's ability to service its debts, government's bond yields may rise through the roof, entailing significant difficulties to service it. Even Ecuador, who had defaulted in 2008 recently said that it wants reissue bonds in foreign currencies.
The crucial point is to demonstrate, as the French audit did, that debt is a political construction, that it doesn't just happen to societies when they supposedly live above their means. This is what justifies calling it illegitimate, and may lead to cancellation procedures. Audits on private debts are also possible, as the Chilean artist Francisco Tapia has recently shown by auditing student loans in an imaginative way.
Do it all you want, nobody is stopping you.
The banks themselves should be put under the supervision of citizens' committees, hence rendering the audit on the debt permanent. In short, debt should be democratised. This, of course, is the harder part, where elements of socialism are introduced at the very core of the system. Yet, to counter the tyranny of debt on every aspect of our lives, there is no alternative. 
Supervision of citizen's committees? Hahaha. Do you know why most of good central banks are independently run? Central bank has to commit itself towards providing a low inflation environment (around 2-3%) and smoothing the peak and the trough of economic cycle.

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