The calls for cutting the federal government’s budget and perhaps even balancing it have continued and are likely to grow louder during this political season. Don’t listen to them unless you want to see a fall in your net financial assets! Government deficits, by definition, create private sector wealth, while surpluses drain it. It’s simple accounting.
To understand this, start by imagining a world in which there is no government and no foreign countries. All economic activity in Australia would take place domestically and be carried out by our private sector firms and households. As a group, they would earn what they spent. If all Australian firms and households spent $1000, then–because one of them was standing on the other side of the cash register for each of these transactions–Australian firms and households would earn $1000. It is logically impossible for them, as a group (though not as individuals), to spend more or less than what they earned–the values must be identical because it’s really double-entry bookkeeping. Every transaction that takes place is both spending (for the person buying something) and income (for the person selling something).
Now create a government. It is only at this point that it becomes possible for one sector (private or government) to spend more than they earned or earn more than they spent. For example, say over its first year in existence, the government takes in $100 in tax revenues but doesn’t spend any of it. You might have something like this:
Government Budget Surplus and Private Sector Deficit
In this case, the private sector spent $1000 on the goods and services it created (which is what created the $1000 in income for them), plus they spent $100 for taxes. The government, meanwhile, earned $100 in income (via taxes), but spent nothing. The government budget is thus is surplus, while the private sector has gone into debt–by the exact same amount, of course. It is impossible for it to work out any other way. The balances must add to zero because, as the last column indicates, total spending must equal total income in a closed system. And with the government in surplus, the private sector goes into debt.
On the other hand, look at what happens when the government spends in deficit:
Now it is the private sector that gets the surplus! In this scenario, the government has collected no taxes, but spent $100 on goods and services produced by the private sector. This creates enough income for the private sector for them to actually save money rather than go into debt.
What the above means is this: government deficits create private sector wealth, while government surpluses drain it. There is no trickery here. When the federal government spends in deficit, it does so by putting financial assets, usually in the form of Treasury Bonds, in the hands of the public; when it spends in surplus, the net quantity of Treasury Bonds held by the public declines. Thus, federal government deficits not only create the extra demand necessary when the economy is at less than full but it puts money in the bank, too. And Australia could never be forced to default on the debt because it is denominated in dollars Furthermore, this is exceedingly unlikely to be inflationary under current conditions..
So, next time you hear Frydenberg or Morrison or Shorten or Bowen or a Coalition or Labor MP talking about reducing the deficit, be sure you put that into the proper context. They are talking about draining your savings account! That’s hardly a sound policy when we have over one million underemployed. This has been a remix of John Harvey's article at Forbes for an Australian audience!
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