Amid all the macho talk about the “sin” of having too much debt, especially federal government debt, an important doubter has emerged.

The Reserve Bank thinks government debt is about appropriate at its current level of 10-12% of GDP (about $244 billion right now). It’s a view that is in conflict with the populist, ignorant view of the federal opposition leader, his Treasury spokesman Joe Hockey and the Finance spokesman Andrew Robb, and a fleet of media commentators, economists and some business groups — such as the Business Council’s sloppy “budget submission” in today’s press.

The BCA wants everybody bar business to scrimp and save for a “stabilisation fund”, which if called upon would be used to help business, much the way the federal government helped business during the GFC with tens of billions of dollars in spending. The BCA wants the fund to be created when public debt has been paid down.

The RBA’s view was given by assistant governor Guy Debelle (who oversees the country’s financial markets) in an answer to a question at a finance conference in Sydney last Tuesday about the level of Commonwealth Government Securities (CGS) on issue. He said the current level of “10-12% of GDP was about what was necessary to maintain a liquid bond market, given the demands of the bond market going forward. So that certainly, from my perspective, from our perspective, from the bank’s perspective, in terms of maintaining a liquid bond market, we think it would be desirable to maintain the stock on issue at some number around that in the medium term. It’s around about where it is at the moment.”

When the much trumpeted paydown of debt by the Howard government saw the value of bonds on issue reach $50 billion around 2006, the bond market became highly illiquid and useless for banks, insurers and the RBA.

Banks now need more government bonds than ever for the new capital rules set by our regulators, working from the new standards coming from the Basel banking committees. We could see about $190 billion needed for the new capital rules starting in 2015. It’s yet another example of how returning to the so-called “golden age of prosperity” of the Howard years just won’t work.

If the level of bonds is reduced, the banks will have to use the new facility being developed by the RBA, which will effectively offer its balance sheet to stand behind the banks. That’s called a Committed Loan Facility and banks will have to work out and take up an agreed amount from that facility to top up their liquidity needs to meet the new rules. The transition to the new rules starts next year.

This is the principal reason the RBA and other regulators don’t want to see a reduction in the level of federal debt on issue. Returning to the levels John Howard and Peter Costello did would make the job of the RBA and APRA harder and expose the bank and taxpayers to greater risks. It also reduces the ability of pension funds, insurers and others to cover their long-term liabilities.

For the moment the CGS market has seen a huge rally in the past year months as buyers — the majority foreign and central banks and sovereign wealth funds –have bought our bonds with their ears pinned back.

At the same conference last week, Dr Debelle said: “Over the first three quarters of 2011, the net purchases of government securities by foreigners amounted to over 3% of GDP, markedly larger than the current account deficit. This pattern of capital flows likely continued in the December quarter … our estimate is that around 75% of the stock of Commonwealth Government Securities (CGS) is held offshore, as at end September. Our discussions with market participants suggest that a sizeable share of recent purchases has been by sovereign asset managers.”

The buyers want to hold on to these bonds. both for a return, but especially for asset diversification reasons away from the US dollar and the euro.

And it’s not just the RBA that thinks that way: the banks, insurance companies, APRA (the other key regulator) and no doubt federal Treasury share the same view of federal government debt– it was the opinion of a government/regulator/industry committee set up to examine the subject after the 2011 federal budget.

Reducing the amount of federal government bonds on issue, whether in service of a political agenda from the opposition or because of the debt obsessives in the media, would be counterproductive.

Perhaps RBA governor Glenn Stevens might this week be able to enlighten those in federal Parliament and outside who don’t understand the changed role the federal government’s debt has in the economy. Stevens makes his first appearance in public this week for the year on Wednesday in Sydney on a panel at a business conference in Sydney. On Friday makes his first appearance for the year before the House of Representatives Standing Committee on Economics, also in Sydney.

Peter Fray

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