Op-ed in The Australian that attacks my guardian article is incoherent

There are no laws in economics. Free market and small government ideology are trojan horses for plutocracy.

The below op-ed was published in last week’s Australian. It is critical of my piece in The Guardian the week before. I contemplated publishing a reply but after reading the piece properly there’s actually very little substance to reply to. I know it’s an opinion piece and there’s not a lot of space to mount a proper argument but it’s very puzzling to me that a professor of finance would bother to write such an empty piece and that The Australian would publish it (OK, perhaps not entirely surprising as ideology is a pretty obvious explanation for both events). Anyway, here is the piece in quote marks with my response interspersed. If you want to read the uninterrupted piece from The Aus then follow the link below.

Federal finances and family budgets have a great deal in common

 WHEN Finance Minister Mathias Cormann said earlier this month said that it was “unfair to rob our children and grandchildren of their opportunities to pay for today’s lifestyle”, he was attacked by economists from all sides of the political spectrum.

Warwick Smith wrote in The Guardian on January 9: “Repeat after me: the Australian economy is not like a household budget”, and said the Abbott government’s attempt to justify reining in budget deficits on these grounds is one of the “great myths of modern government financing”.

My friend and unreconstructed Keynesian economist Geoff Harcourt accuses the government, on the website The Conversation, of “deficit size fetishism” and denies the “supposed link between (deficits) and the welfare of future generations”.

My colleague Richard Holden denied in The Weekend Australian on January 10 denied that the national economy is like a household and said it was “misguided” to think that governments, like families, must live within their means.

The government’s difficult task is not helped by economists who believe that any restraint advocated by governments of a persuasion they may not like is pure ideology and that the clear and obvious analogy with household and family budgets has no relevance.

I think this last paragraph is something of a straw-man as it doesn’t accurately represent the content of the articles in question. In my case, what I argued was that inflation should be used as the constraint for government spending instead of taxes and borrowing and that comparisons with households are irrelevant. This is different from arguing that restraint by the Coalition is ideological (I think it is but that is actually a separate matter). As best I can tell all Australian politicians make use of these false analogies.

I suspect the need to begin this piece with a straw-man reveals the entire story behind this op-ed: the author has no argument to make but simply doesn’t like the conclusion reached by the economists (including myself) he cites and misrepresents.

There is a very important insight contained in the above exchange between Professor Swan and I. Economic policy is fundamentally about the translation of values. This is not science, it’s philosophy. Your economic policy is going to depend on the kind of society you want. The economic policy – indeed the very economic system – follows on from decisions about values.

Popular radio personality Alan Jones tells his listeners that governments are subject to the same laws of economics, same resource scarcity, and same need not to waste the taxpayer’s scarce dollar as the families whose tax payments make government possible.

Have he and his listeners been conned, if not Cormanned?

Yes they have. There are no “laws of economics”. Economics is not a natural science like physics. Our economic system is a construct and nowhere is this more obvious that in monetary economics. To think that there are somehow laws of economics is to have fallen victim to the greatest con of our age. We constructed the economic system and we can reconstruct it if it’s not working for us.

Smith, a research economist, is convinced Jones and his listeners are wrong because “the federal government can create money”. Certainly, some governments have tried to pay their debts by printing money; Zimbabwe’s Robert Mugabe comes to mind.

So, first the logical fallacy of the straw-man is used. Next the logical fallacy of guilt by association. Zimbabwe is the economics equivalent of Hitler and the Nazis – you know the drill, mention somebody or some policy and Hitler in the same sentence and you make them look bad by association. “Does Peter not realise that Hitler was elected and therefore democracy is a flawed political system?”

Professor Swan is making exactly this kind of empty attack by invoking Zimbabwe in a discussion of money creation. What he fails to mention is that first Mugabe destroyed Zimbabwe’s productive capacity and then tried to print the country’s way out of economic trouble. Last I noticed Australia still had productive capacity and the point of my article was that you can create money when there is spare productive capacity i.e. in conditions precisely the opposite of those that existed in Zimbabwe. I don’t know if Professor Swan understands this but chose not to say it because it undermined his argument or if he doesn’t understand it. Neither paints a very flattering picture of his op-ed.

But so can individuals. Every household and family has a perfect legal right to create its own exclusive fiat money, Peter Swan banknotes.

In this sense, you and I are no different to Zimbabwe and Mugabe. My currency and his are rightly rejected as worthless, forcing Zimbabwe to use US dollar denominated currency, as does, effectively, Hong Kong.

The federal government does differ from you and me in one respect, though: it can and does pass laws making Australian banknotes legal tender.

Thus domestic households have to accept Australian dollar denominated currency and if they purchase federal government debt denominated in Australian dollars they take the risk of its value being eroded by Australian governments when they create inflation.

Is it only me who finds this pretty amusing? What Professor Swan is effectively saying here is that individuals and households are exactly the same as the federal government except in a few critical ways that make them completely different. He also fails to mention one other fundamentally important difference which is that individuals and companies in Australia are required to pay tax in Australian dollars.

The consequences of these differences between households and the federal government are profound. Again, it’s wild that Professor Swan would glibly state this fundamental difference between households and government as if it’s inconsequential. It’s true that I can create my own currency but I cannot force anybody to use it nor force anybody to pay me using it. The federal government can do these things and the flow on consequences are as fundamental to our financial system as energy is to our real economy.

Australians holding our wartime debt whose wealth was severely depleted by the inflation that occurred during the Korean War-inspired wool boom in the early 1950s experienced this.

Professor Swan now makes a huge and unjustified leap to start discussing the negative consequences of inflation. There are two possibilities here: he either didn’t read my article or he’s deliberately distorting it in order to make his argument. The whole focus of my piece was on using inflation as the guide and limit to government expenditure. If inflation is the primary focus then why would he expect there to be high inflation? The only way inflation would be a problem under a system which specifically focusses on inflation is incompetence. The idea is to use both monetary and fiscal policy working together using economic capacity and inflation as their guiding measures.

Australia is a massive capital importing nation depending almost entirely on foreign rather than domestic savings to fund federal government deficits. These lenders are sufficiently sophisticated not to fall into the domestic inflation trap. So much of the borrowing is denominated in American or other global currencies, putting the federal government on a similar basis to the states. Queensland has already lost its AAA credit rating crown. Unless the federal government can balance the budget and pay down debt, it risks following suit.

This is simply false. Virtually all Australian government debt is denominated in Australian dollars. In Professor Swan’s defence, prior to the 1980’s what he said was true. Perhaps he needs to update his figures.

Printing money simply devalues the Australian dollar, magnifying both the interest and the principal repayment burden.

Even for an op-ed this is mind-boggling in its lack of nuance. How much has the creation of trillions of dollars in the US during quantitative easing devalued the US dollar? How much inflation has it caused? What’s the interest and principal repayment impact? I’ll give you a clue – virtually no impact on any of these things at all. Yes, printing money when there is no spare capacity in the economy has negative consequences. Hint – don’t do it then, do it when there’s the capacity to absorb it. It’s not that hard.

Harcourt, however, believes it is a fallacy that the federal government needs to balance its budget over the economic cycle. Nor does he believe there is a problem with internal debt as it postpones the need for higher taxes, resulting only in the payment of more interest to Australian lenders.

This he regards as a transfer even though taxpayers and lenders need not be one and the same.

Harcourt believes there may be a case for foreign borrowing to pay for social infrastructure, even though he admits that higher exports will be required to repay the debt. However, this leaves us paying a rising international interest bill just to meet budget outlays into the indefinite future.

Holden argues that the analogy with household budgets is inappropriate because unlike mere mortals, governments live forever. He thinks that families “pay down that debt through prudent spending” only because they want to leave something to their children.

This does not obviate the need for governments to repay debt to prevent the interest burden paid by future generations blowing out beyond their diminishing capacity to pay, with the end of the baby boom generation, the ageing of the population, and collapse in our terms of trade. Holden points out that “government doesn’t make stuff and it doesn’t create jobs or wealth”. I agree with this pro-market, anti-Keynesian sentiment. With properly enforced property rights in place the private sector can be left to provide social infrastructure such as hospitals and, presumably, toll roads.

As I’ve argued elsewhere, the whole government debt burdening future generations thing is just another myth. Future generations standard of living will not be burdened or restricted by our debt. Their standard of living will be restricted by the goods and services they produce. As Warren Mosler says, you can’t send goods and services back in time to pay for past expenditure. You only have to think outside the household analogy to realise that what Professor Swan says here is illogical. Only if people like him hold sway on governments will today’s debt impact on future generation’s standard of living because they will impose mindless austerity policies on future generations in order to achieve their aims of privatising and financialising our entire lives.

There is a cost of governments overspending today and that cost is inflation today. This is why inflation is the best constraint on government expenditure. It seems this point entirely escaped Professor Swan. As Upton Sinclair said “It is difficult to get a man to understand something, when his salary depends on his not understanding it.” Similarly it is difficult to get somebody to understand something if it undermines their entire career’s work. Professor Swan’s resistance is understandable in this context. However, as physicist Max Planck put it “[a] new scientific truth does not triumph by convincing its opponents and making them see the light, but rather because its opponents eventually die, and a new generation grows up that is familiar with it.” These are not scientific truths that we are discussing but they are the realities of modern finance as we have constructed it.

The federal government does not need to incur ever-rising deficits and debt to provide law and order and enforce property rights. Hence Holden’s arguments seem to indicate a close analogy ­between government and household debt.

Finally we get to the substance of this article. Professor Swan is a small government, free-market advocate. At the very extreme end of this spectrum are those who think the role of government should be restricted to law enforcement, national security and the enforcement of property rights. It’s code for handing all the power in society over to the rich. There is no equal opportunity in a laissez-faire economy. If you’re born wealthy you will very likely succeed and if you’re not you won’t. It seems that’s the Australia that Professor Swan wants. Unfortunately for him he’s completely out of step with the overwhelming majority of Australians who see the government’s role as much greater than that.

Both must be prudently managed and debt levels kept in check so as not to destroy the bequest motive (households) and to prevent interest payments alone absorbing the limited capacity to raise revenue (governments).

None of these three advocates for essentially unlimited public debt has in my estimation made the case, or even shown how it is possible, without a breakdown of society. The bailout crisis in Greece is a case in point. The analogy between government and household budgets remains intact.

Peter Swan is professor of finance in the school of banking and finance, UNSW Business School.

This last paragraph is like the Zimbabwe fallacy but an even worse attempt at guilt by association. It demonstrates once again that Professor Swan is trapped in a pre 1970s framework. The post Bretton Woods financial world is radically different from that under Bretton Woods between WWII and 1971. That Professor Swan would use Greece as a warning for Australia shows us that he doesn’t understand the post Bretton Woods era. Because Greece does not have the capacity to create its own currency it is out of options. The Euro cannot save Greece. If Greece still had its own currency it would have a raft of options for escaping its current problems including money creation for economic stimulus. There is plenty of spare capacity in the Greek economy to absorb money creation without causing inflation – no Professor Swan, Greece is not comparable to Zimbabwe.

It’s taken a lot of words to show it but the op-ed in The Australian contained no coherent argument against my Guardian article or the others cited by Professor Swan. Ultimately he reveals his motivation in the third last paragraph where he advocates for a system that hands virtually all power in society to the wealthy. In other words, Professor Swan advocates for a plutocracy in the guise of a small government, free market economy. That’s not what I want and, happily, it’s not what the overwhelming majority of Australians want. It’s important that we watch out for trojan horses like those that Professor Swan and the editors of The Australian offer us.

Warwick Smith

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1 Response to Op-ed in The Australian that attacks my guardian article is incoherent

  1. David says:

    I like that Professor Swan cites Alan Jones. Not affording him expert status or explicitly calling him forth, just turning him on dimly in the background. Stay classy Professor.

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