Clearing the national debt
While clearing the national debt is not an integral or essential part of our reforms, we are of the opinion that it should be done. This debt exists partly because government handed the profits of creating new money over to private companies (the banks) at the cost of over $125 billion in lost revenue (and additional taxes that we had to pay) between 1990 and 2010 alone.
Interest payments on the national debt are a major, and growing, portion of government (i.e. taxpayers’) expenditure.
Is it right that we should be spending as much on interest payments as we do on education, while banks are still permitted to create around $10 bn of new money each year and lend this into the economy, generating massive interest payments for themselves?
- Recommendation for clearing the national debt
- What does the national debt consist of?
- Why we need to pay off the national debt slowly
- Paying it off too quickly could harm pensioners.
- The National debt is cheap while personal debt is expensive
- Why can't we just create new money to pay off the National debt?
- Why we just can’t pay it off immediately
- One beneficial side effect of paying off the National Debt
Recommendation for clearing the national debt
We suggest that over the 30 years after implementing the modernised system, national debt should be reduced to no more than 5% of GDP. Realistically, it should be possible to completely clear the national debt and for fluctuations in the government's income to be made up from its own savings.
However, there may be situations in which the government needs some 'breathing space' so we have avoided setting the target for national debt at 0% of GDP.
What does the national debt consist of?
Government debt consists of government bonds. A bond is essentially a contract which states something along the lines of:
This bond is worth $XXXX. The NZ government will pay you an interest rate of X.X% per annum on the principal (non-compounding), and at the end of XX years will repay the principal too.
The bond is a certificate, and whoever holds the bond in their possession is considered to be the owner of it (i.e. there is no named owner, unlike a mortgage contract or personal loan). As a result, bonds are easily bought and sold on the ‘secondary’ market (i.e. second-hand).
Why we need to pay off the national debt slowly
In order to prevent disruption in the financial markets (which would hurt pensioners more than anyone else), we have to pay the national debt off gradually over a period of time. Although it would be tempting to suggest that we should pay off the national debt as quickly as possible, there are a few strong reasons why we shouldn't:
Paying it off too quickly could harm pensioners.
The majority of these bonds are not owned by the banks. Around 40% is owned by foreign investors. However, the big concern for us is the 40% of government bonds that are owned by pension funds and insurance companies.
To see why it is crucial that we do not pay off the debt too quickly, you need to step into the shoes of a pension fund manager.
Pension funds like to buy government bonds because they know these bonds will always be repaid. Bonds are therefore considered as safe as cash, with the added bonus that they pay interest.
Consequently, pension funds, especially those with a large number of customers near retirement age, will use bonds to make up a large percentage of their portfolios - after all, bonds are much safer than stocks and the pension fund will not want stock market volatility to wipe out its (and its customers) assets.
The fund manager needs to ensure that the investment portfolio has a range of low-risk, steady return investments, and higher-risk, higher-return investments. The lowest-risk investment that still offers a return is government bonds, so these make up the 'safe' part of the portfolio.
When we "pay off" part of the national debt, we are actually reducing the quantity of government bonds in the market. If we reduce the quantity of bonds in the market too quickly, we force these pension fund managers to shift their investments from bonds to other investments, such as corporate bonds (more risky) and the stock market (much more risky).
The effect of $31.6 billion (the national debt at September 2010) shifting from the bond market to the stock market and corporate bond market would be like tipping a bath of water into a small pond - creating huge waves in the market.
Firstly, prices of stocks would start to rise, probably creating a bubble in the stock market. However, as people started to fear that the bubble was getting too big, they would start to 'pull out' of the market by selling shares.
This may trigger another stock market crash as pension funds rapidly try to move their money into cash. The result would be, once again, a dramatic reduction of the value of pensions, which would harm pensioners and those in middle-age most of all.
To avoid this, we need to remove bonds gradually from circulation over a period of time. Fund managers would be well aware that government bonds were being 'phased out', but would have around ten to fifteen years in which they could gradually shift their investments away from the bond market and into corporate bonds and the stock market.
This would avoid causing any bubbles in the market, avoid a flood of 'cheap' money into the corporate bond market (which would most likely lead to some pointless and badly chosen corporate takeovers if done quickly), and safeguard the value of pensions.
The National debt is cheap while personal debt is expensive
The overall interest rate on the national debt works out at around 3.5% per annum. It is low because government debt is assumed to be risk free, so pension funds and other buyers of government debt are willing to accept low returns in return for absolutely zero risk of default.
In contrast, the interest rate for household debt ranges from 6% or so for mortgages, right up to ≈17% on credit cards. Overall, the average interest rate is undoubtedly higher for households than it is for the government.
Let's assume that the interest rate for all household debt averages out at 8% per annum. Total household debt is significantly greater than total government debt ($221 billion compared to $31 billion as of September 2010).
A basic principle in debt management is to pay off the most expensive debt first. If we acknowledge that national debt is really the debt of the NZ taxpayers (amounting to approximately $10,000 per eligible voter), then the national debt is the cheapest debt and should be paid off later than household debt.
For this reason, it is better to divert more money back to the public (via tax cuts, public spending or direct payments to citizens) than to aggressively pay down the national debt. The money directed to the public will then allow them to pay down their more expensive debts.
That doesn't mean we shouldn’t make inroads into paying down the national debt. As a general principle, we would recommend that the national debt should be paid down by around $500 million per annum, using government revenue from taxation and/or the year's newly-created money.
Why can't we just create new money to pay off the National debt?
Recall that each month the Monetary Policy Committee would make a judgment on how much new money the economy needs, and then authorise the Reserve Bank to create it. This newly-created money would then be given to the government to supplement revenue raised from taxation. Repayments on the national debt must come out of the government's total revenue, which will be a mix of tax revenue and newly-created money (with the overwhelming majority being tax revenue).
Consequently, if the MPC decided in a particular year that no addition to the money supply was needed, then the government would need to repay the national debt from tax revenue.
The question has been asked, why don't we just create money specifically to repay the national debt, or repay all bonds with newly-created money as they mature? There are two reasons why this would be counter-productive.
Firstly, the MPC is making a decision on how much money should be created on the basis of the needs of the economy. We should not create any more additional money than the economy requires in a particular time period. The bonds that make up the national debt mature at different times over the next 60 years.
Simply creating the money to pay for these would completely unbalance the decisions made by the MPC. Consequently we need to separate the decision over how much new money is created, and how the national debt is repaid.
The second reason is mostly psychological. Creating money specifically to pay off the national debt - with no consideration of the needs of the economy - sounds a little like the disastrous approaches taken by dictators of certain economies over the last few decades. Such a policy would potentially trigger a flight from the NZ dollar in the currency markets and devalue the bonds in the eyes of the holders of that debt.
To avoid this, the national debt has to be repaid gradually, and repaying the debt has to incur a cost on the public (either via taxation, or via the 'opportunity cost' of what they could have had if the money had not been used to repay the debt). There is no quick and easy solution to the national debt.
Why we just can’t pay it off immediately
It would be tempting to just create the money to pay off the debt in one fell swoop. However, doing so would be a disaster for two reasons:
1. The national debt currently stands at around $31.6 billion (although it is increasing rapidly). This amounts to around 20% of the total money supply. Increasing the money supply by 20% in one year will create massive inflation, and by definition, devalue the dollar and any money or savings that you hold.
2. As outlined above, recalling all government bonds at once would cause a massive flow of investment money into corporate bonds and stock markets, causing massive volatility in these markets and most likely damaging the value of pensions.
One beneficial side effect of paying off the National Debt
Besides no longer having to pay interest on it, paying off the national debt has other benefits for the economy.The next safest option after government debt is the debt of the 'blue chip', NZSX companies.
By investing in bonds or even new share issues from these companies, these companies should be able to pay off more expensive debt, which in theory should lead to lower costs for customers, or more jobs being created, or more profit being declared and therefore more tax being paid.
At the same time, when large corporations can borrow cheaply from pension funds looking for a safe haven for their money, they will have no need to borrow from banks. Consequently the banks will themselves need to look for other investment opportunities. They will need to shift their focus to investing in small and medium sized businesses.
The end result of phasing out government bonds is that small and medium businesses will start to find it much easier to get funding from banks, which should be beneficial for the economy. By clearing the national debt, we channel more credit / investment to businesses rather than to government.