Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 63

Running up and paying off government debt

In Part 1, we looked at the record of Labor (or left-leaning) and Liberal (or right-leaning) governments in running government surpluses or deficits. Both sides have run few government surpluses since Federation, and Labor ran more frequent and larger deficits than Liberal governments.

This week we focus on the lower section of Chart 1, showing Commonwealth government debt as a per cent of GDP (Gross Domestic Product, or national output, income and expenditure).

Chart 1: Federal government deficits and debt since Federation

Funding the war efforts

The main debt build-ups were caused by the massive deficit spending war efforts in the two World Wars. Both happened to be on Labor’s watch, but both were bi-partisan, and so should not be attributed to Labor profligacy.

The debt-to-GDP ratio also increased during the 1930s depression, but it was not due to deficit spending. Between 1929 and 1932 the nominal level of debt was actually reduced by 15% but the level of national income (GDP) contracted by even more, a staggering 31% (half of which was due to a real GDP contraction and the other half price deflation in the depression), so the debt to GDP ratio increased even though the amount of debt fell.

Australia did not adopt a Keynesian deficit spending spree during the 1930s depression like the US because we simply were not able to. The Commonwealth and state governments had run out of credit in foreign debt markets by 1929, and the government’s then wholly-owned Commonwealth Bank refused to lend it more money. The only option was to stick to the savage and deflationary austerity of the 1931 ‘Premiers’ Plan’ and force all holders of domestic government debt into a 22.5% haircut restructure deal (a-la the Greek restructure in the recent European sovereign debt crisis).

Much like the Abbott Liberal Government today, the break-away United Australia Party won the 1931 election on promises to abandon Labor’s austerity plan but, immediately after being elected, ditched those promises, endorsed Labor’s austerity plan and cut spending savagely. The difference was that in 1931 nobody would lend to Australia. The spending cuts, together with interest savings from the debt restructure ‘haircut’, resulted in three government surpluses - in 1933, 1934 and 1936. These can be seen in the top section of Chart 1 above.

Current level of government debt

Chart 1 also shows that the recent Rudd/Gillard deficits were similar in scale to the Fraser, Hawke and Keating deficit eras. Contrary to popular myth the Whitlam era was not one of high deficits or high debt. The only significant deficit was in 1975, with the budget crisis triggering the controversial sacking of the Whitlam government by Governor General Sir John Kerr on behalf of the Queen.

How does Australia compare?

Chart 2 shows how Australia’s level of government debt compares with the rest of the world.

Chart 2: Government Debt to GDP ratios

Here we see that even after the post-GFC debt build-up caused by borrowing to fund the Rudd/Gillard deficits, Australia’s current level of government debt is very low relative to almost all other countries. Even Australia’s war-time debt levels were lower than several countries today – notably Japan and the ‘PIIGS’. We reduced our debt levels over time by growing the economy, not by ‘paying it off’, and so can they.

Debt servicing levels (interest paid to service government debt)

Chart 3 shows the interest burden of the government debt, expressed in terms of interest cost as a percentage of GDP and also interest cost as a percentage of government receipts (mainly tax revenues).

Chart 3: Federal government debt and interest burden

Interest payments on Federal government debt consumed 30-40% of all Federal government revenues in the 1920s (on a par with the European ‘PIIGS’ and Japan today). Interest was still consuming more than 10% of revenues in the 1930s and 1940s (on a par with the US today). The interest burden was then brought down in the post-war boom in the 1950s and 1960s.

Paying off the debt

The debt service burden relative to national income (shown as the red line in Chart 3) was brought down from its astronomical levels in World War 2 primarily by growing the size the national economy rather than reducing the absolute level of debt, which continued to rise in dollar terms.

In recent years, the interest burden of government debt was at its lowest level ever in 2007-2008, when the level of debt was also at its lowest, but interest costs and debt levels have risen sharply since 2008.

However, Australia’s interest burden in recent years (at around 1% of GDP and 3-4% of tax receipts) is no higher than it was in the 1950s to the 1970s. This is partly due to the relatively low level of debt, and also partly due to the relatively low interest rates today.

Some conclusions

  • The current level of Commonwealth government debt relative to national income is modest, and is lower than almost any other time since World War 1. It is also lower than almost all other countries in the world today. The only times it was lower than today’s levels was in the late 1960s to mid-1970s, and in the late 1980s.
  • Current interest burden on Commonwealth debt (as a % of national income and also as a % of government receipts) is also very modest, and is lower than almost any other time since before World War 1. World War funding was bi-partisan.
  • Although market yields on government bonds have been rising since July 2012 from their ultra-low post-GFC levels, rising bond yields don’t translate into higher interest payments on the bonds until each bond series matures and is re-financed, which in many cases is more than a decade into the future. Hence the government’s recent shift to longer bond maturities in order to lock in lower interest rates for longer.
  • Governments generally do not reduce debt levels by ‘paying off debt’ per se, but instead the size of the economy grows and that reduces the ratio of debt to national income. The two occasions when governments did actually pay off debt with government surpluses were in the 1930s depression (under Labor) and in the late 1990s to 2000s (under Liberal).

In Part 3, we will look at what really matters to investors - the impact of government deficits and surpluses on stock market returns, under Labor and Liberal governments.

 

Ashley Owen is Joint CEO of Philo Capital Advisers and a director and adviser to the Third Link Growth Fund.

 

RELATED ARTICLES

Budget time and Labor v Liberal on fiscal discipline

Which political party is best for share prices?

Super concessions to overtake Age Pension costs

banner

Most viewed in recent weeks

2024/25 super thresholds – key changes and implications

The ATO has released all the superannuation rates and thresholds that will apply from 1 July 2024. Here's what’s changing and what’s not, and some key considerations and opportunities in the lead up to 30 June and beyond.

The greatest investor you’ve never heard of

Jim Simons has achieved breathtaking returns of 62% p.a. over 33 years, a track record like no other, yet he remains little known to the public. Here’s how he’s done it, and the lessons that can be applied to our own investing.

Five months on from cancer diagnosis

Life has radically shifted with my brain cancer, and I don’t know if it will ever be the same again. After decades of writing and a dozen years with Firstlinks, I still want to contribute, but exactly how and when I do that is unclear.

Is Australia ready for its population growth over the next decade?

Australia will have 3.7 million more people in a decade's time, though the growth won't be evenly distributed. Over 85s will see the fastest growth, while the number of younger people will barely rise. 

Welcome to Firstlinks Edition 552 with weekend update

Being rich is having a high-paying job and accumulating fancy houses and cars, while being wealthy is owning assets that provide passive income, as well as freedom and flexibility. Knowing the difference can reframe your life.

  • 21 March 2024

Why LICs may be close to bottoming

Investor disgust, consolidation, de-listings, price discounts, activist investors entering - it’s what typically happens at business cycle troughs, and it’s happening to LICs now. That may present a potential opportunity.

Latest Updates

Shares

20 US stocks to buy and hold forever

Recently, I compiled a list of ASX stocks that you could buy and hold forever. Here’s a follow-up list of US stocks that you could own indefinitely, including well-known names like Microsoft, as well as lesser-known gems.

The public servants demanding $3m super tax exemption

The $3 million super tax will capture retired, and soon to retire, public servants and politicians who are members of defined benefit superannuation schemes. Lobbying efforts for exemptions to the tax are intensifying.

Property

Baby Boomer housing needs

Baby boomers will account for a third of population growth between 2024 and 2029, making this generation the biggest age-related growth sector over this period. They will shape the housing market with their unique preferences.

SMSF strategies

Meg on SMSFs: When the first member of a couple dies

The surviving spouse has a lot to think about when a member of an SMSF dies. While it pays to understand the options quickly, often they’re best served by moving a little more slowly before making final decisions.

Shares

Small caps are compelling but not for the reasons you might think...

Your author prematurely advocated investing in small caps almost 12 months ago. Since then, the investment landscape has changed, and there are even more reasons to believe small caps are likely to outperform going forward.

Taxation

The mixed fortunes of tax reform in Australia, part 2

Since Federation, reforms to our tax system have proven difficult. Yet they're too important to leave in the too-hard basket, and here's a look at the key ingredients that make a tax reform exercise work, or not.

Investment strategies

8 ways that AI will impact how we invest

AI is affecting ever expanding fields of human activity, and the way we invest is no exception. Here's how investors, advisors and investment managers can better prepare to manage the opportunities and risks that come with AI.

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.