A FAQ On Malaysian Government Debt: Part III

[Since there’s a request for a simpler, more understandable version of the last two posts, this is the condensed version, with answers in two paragraphs or less. The full FAQ can be accessedhere]

Q1. Government debt is like household debt – if we spend more than we earn, we’ll go bankrupt

A. That’s the common sense view, and its one that’s commonly held. The problem is that it’s also mostly wrong. Households’ ability to service debt is limited by their ability to earn income. For the government, its income (taxation) is determined by itself. Moreover most governments reserve a monopoly on the issuance of money, which means it can always print money to pay its debts.

Lots of people have objections to printing money and they’re mostly correct, but there is a safe limit for this which is the ability of an economy to produce goods and services. Beyond that point is where printing money leads to inflation and eventually hyperinflation. Which leads to the next point.

Q2. Bigger and bigger amounts of government debt is inflationary

A. Debt itself is not inflationary – that depends on what the debt is used for. Inflation occurs when total demand in an economy – the sum of spending by households, companies and government – is greater than the amount of goods and services produced. The only way for government spending to be inflationary is when it causes total demand from all three sectors to exceed that limit.

If there is a gap between actual output and the potential output of an economy, extra government spending will not be inflationary, debt financed or not.

Q3. The Malaysian government has been running a deficit for years – but it should only be running a deficit in bad times. In good times, it ought to be saving and paying down debt

A. The goal of any macro-stabilisation mechanism is to achieve full employment (and this means not just labour but productive capacity) in an economy. If for some reason households and companies want to save more, to maintain an economy’s full employment status requires the third sector (government) to dis-save i.e. borrow and run a deficit. Only if private spending in an economy exceeds its productive capacity should a government start saving, i.e. run a budget surplus.

So it’s not just a binary decision of good times (save)/bad times (spend) for government expenditure.

Q4. All this increase in debt will be a burden on our children and our children’s children

A. Whether government debt accumulation will become a burden on future generations depends greatly on who the debt is owed to. If the debt is held by citizens or agencies acting on the citizens’ behalf (for example EPF), then the taxes raised to pay for maturing debt comes from citizens and the debt payment goes back to citizens. All that occurs is a change in financial obligations and possibly some redistribution of wealth, but not a net burden on taxpayers.

In Malaysia, only about a fifth of government debt is held by foreigners, with the remainder being held by EPF, SOCSO, insurance funds, pension funds, banks and the like.

Q5. Government debt growth is being aided and abetted by our pension and investment funds, which are now at risk

A. Government debt typically forms the benchmark for all bond issues in an economy – as governments essentially determine their own level of income, government securities are far safer than that of corporate or household debt. Even the best rated companies pay more on their debt than the government of their country.

It goes back to the safety factor. That’s why pension funds and insurance companies put most of their investible funds into government securities. Whatever the risk of investing in government securities, every alternative except cash is riskier.

Q6. Since most of government debt is owned by Malaysians and only some by foreigners, the foreigners will get paid first while we have to pick up the bill

A. Historically when countries do default, it’s almost always a default on external debt, not on the debt held by domestic institutions. It’s not hard to figure out why – when we’re talking about citizens, no democratically elected government would dare default on its debt obligations as it risks being booted out otherwise. Same thing for institutions such as pension funds and insurance funds, which take care of the future financial needs of their investors (read: voters). For banks, a domestic default could mean the government needing to bail them out, which makes a default worthless.

So foreigners are always first in the firing line, which makes them understandably skittish.

Q7. The government went on a spending spree during the recession

A. When the recession of 2008-2009 hit, the government instituted two fiscal stimulus packages with a face value of RM67 billion. But only a little over half of that constituted spending plans, and when all was said and done, Government expenditure in 2009 was only about RM1.4 billion higher than the original 2009 budget proposals sent to Parliament in 2008.

What happened was that, although the money for the stimulus packages was certainly spent, almost all of the funding for the extra spending didn’t come from extra borrowing but from cuts in other government programs and services. The increase in debt over the same period didn’t occur because of an increase in overall spending but because government revenue came in at 10% below the budget estimates - in fact a little worse than the contraction in 2009 GDP of 9.9%:

Q8. We’re in trouble because debt has doubled in the past five years while income hasn’t

A. This is almost true, but wholly misleading. The key point is that the recession seriously dented not just government income but the nation’s nominal income as a whole – the recovery in 2010 saw national income only just passing the level reached in 2008. In the meantime, the government had to deal with the drop in revenue in 2009, and thus had to borrow to cover the difference.

Looking at the growth rates, debt growth actually lagged income growth from 2005-2007, and since the recovery has come down to more sustainable levels. As long as debt growth is more or less in line with income growth, we should be fine.

Q9. Government debt isn’t sustainable because operational spending is greater than revenue

A. The government’s operational balance has been negative in just three years out of the last 40, and it has not been in deficit since 1987. As required by law, the government only borrows to finance development expenditure, i.e. investment that will raise future capacity to produce.

Q10. Government debt is nearing the legal debt limit, and they won’t be able to borrow anymore so we’ll have to default

A. satD has covered this question in detail, so I won’t post more than a summary – the legal limit is a paper tiger and the government can change it anytime it wants. If at any point the government fails to gain legislative approval to raise the limit, in our system of parliamentary democracy that means an immediate dissolution of parliament and fresh general elections. We’re not America.

Q11. The Treasury says the national debt is RM240 billion but the outstanding government debt is RM437, someone must be lying

A. It’s a funny thing but in Malaysia, we don’t use the term “national debt” in the way it’s commonly used elsewhere. Here the term refers exclusively to external debt only, of both the public and private sectors, and not to government debt.

So in Malaysia, government debt and national debt mean two very different things. The government’s external debt, by the way, is all of RM17 billion.

Q12. In ten years time, we’ll be like Greece

A. Greece has a 2000 year history of defaulting on its external debt; has spent half of the last 200 years in a state of default; a debt to income ratio over 100% for the last twenty years; and owes three quarters of its debt to foreigners. Moreover, Greece is also part of the Eurozone and thus has no control over the issuance of its own money. Worse, the European Central Bank is legally bared from becoming a lender of last resort for the Eurozone governments. Greece is uncompetitive – it costs 40% more for a Greek worker to produce a unit of output compared to a German one.

Malaysia is not Greece, and we’re not exactly in danger of becoming one in the next ten years.