Land of the Tweedles

Figure 4

Secondly, it's a nonsense to argue, on an analogy with households, that government debt can bankrupt a government that has a captive Central Bank. If a household spends more than it earns, then after it exhausts its supply of credit, it is bankrupt. But if a government spends more than it taxes, it accumulates a debt to its Central Bank... which it can pay by borrowing from its Central Bank. Unlike a private bank, a Central Bank can't refuse to lend to its primary borrower.

So Federal Government in the USA or Australia won't go bankrupt-though their States could, as could the Eurozone countries of Europe. Hence, what should be discussed are the economic consequences of running a deficit: assuming instead that a government can run out of money is TweedleDumming down the problem.

I apologise for complicating the debate here-Tweedle-dumming a problem is much more catharthic-but the indications are that this is not the time to be reducing government spending in either the USA or Australia. The crisis was caused by accelerating debt-which gives the economy a boost-giving way to decelerating debt-which drives aggregate demand down. This is easily shown by graphing the acceleration of debt-the Credit Impulse-against changes in unemployment (the correlation coefficients in the next two charts are -0.77 and -0.75-extremely high correlations over such a long period with such variable economic conditions).

Figure 5

Though Australia certainly was assisted during the GFC by its sales of coal and iron ore to the Red Queen, the real reason that it "avoided" the GFC was that it restarted the private debt engine more rapidly than America did. The Credit Impulse stopped its plunge at -12 percent of GDP here, versus a peak negative of -26 percent in the USA. Australia also spent less time in the red on the Credit Impulse than the USA: 26 months versus 30.

Figure 6

Now both economies are recovering, not because the physical economies are in good shape-they're both very sick, except for Australia's minerals sector-but because the Credit Impulse has turned positive in both countries.

Figure 7