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‘The economy exists within society, not vice-versa’: Saul Eslake on the GFC, debt-and-deficit and why we need to pay more tax.

Perhaps it always is. But it’s been more than usually messy since 2007, when a real estate bubble in the United States was so badly mismanaged that it sent the world into the Global Financial Crisis. We’re still living with the results.

As that crisis unfolded, a shocked Alan Greenspan, the former longtime chairman of the US Federal Reserve, admitted: “The whole intellectual edifice … collapsed in the summer of last year.”

Saul Eslake remembers it very well indeed. He was chief economist at the ANZ Bank at the time.

“[There was] a particular intellectual framework within which Greenspan had operated,” Saul says, “probably going back to his earliest days when he was a disciple of Ayn Rand, who had a particularly extreme libertarian view of the world.

“Greenspan was not a doctrinaire monetarist, like Milton Friedman, but he had a view that financial markets in particular were self-correcting and did not need a great deal of regulation or oversight. That was a key factor in his resistance to any suggestions during his term that, for example, there ought to be greater regulation of derivatives.”

Greenspan’s 19 years as head of the Federal Reserve were salad days for armies of creative financial “engineers” who designed investment products which were increasingly obscure, complex and divorced from underlying assets. They were also – for the big investment banks – hugely profitable. Largely, they provided ways in which speculators could bet on markets rising or falling.


As early as 2002 Warren Buffett, head of Berkshire Hathaway and the most lauded investor of the past half-century, warned of the dangers these imaginative products posed not only to investors but to the entire economy.

In his company’s 2002 annual report, he described derivatives as “financial weapons of mass destruction”.

“The derivatives genie is now well out of the bottle, and these instruments will almost certainly multiply in variety and number until some event makes their toxicity clear,” Buffett warned. “Central banks and governments have so far found no effective way to control, or even monitor, the risks posed by these contracts.

“We try to be alert to any sort of mega-catastrophe risk, and that posture may make us unduly apprehensive about the burgeoning quantities of long-term derivatives contracts … In our view, however, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.”

The result, which Buffett foresaw six years before it happened, was the Global Financial Crisis.

“While I’m not sure the crisis changed as much as some critics at the time thought it would,” Saul told me, “the idea that financial markets can be left more or less to their own devices – ‘light-touch regulation’ – has been discredited.

“One of the lasting consequences of the Global Financial Crisis has been much more prudential supervision of what banks have been up to. While that hasn’t worked perfectly, the fact that the financial systems of most countries functioned pretty well during the pandemic, says that some lessons were learnt from the GFC.


“There were some lessons that weren’t learnt. In particular, the hands-off view that many  governments have about housing. While I think it was right for central banks to go as far as they could in lowering interest rates, more could and should have been done to contain some of the side-effects of the medicines they were prescribing – and particularly to contain yet another bubble in house prices.”

There was, as it turned out, too much stimulus. That’s forgivable, Saul says – doing too much is better than not doing enough.

“What I criticise [central banks] for is not recognising what they could and should have done around this time last year, and start to unwind. Our Reserve Bank continued to insist until November last year that it wouldn’t raise rates until 2024. That reference to the calendar was unique amongst central banks.

“They continued to say inflation wouldn’t be sustainably within their two-to-three per cent target range until they’d seen wage inflation of over three per cent. And here we are with inflation over five and heading to seven, and wage inflation still isn’t over three. And in Australia there’s no connection [between the two].

“Our central bank was behind the curve and now they’re having to play catch-up.”

There is, he believes, a significant chance now of widespread recession in the next 12 to 18 months.

“In my view the odds of Europe being in recession are over 50%; in the US about 50-50; and the odds here, although they’re less than 50%, they’re not zero either.”


The economic ideologies that ended so badly – that markets work perfectly by themselves and governments should just bug out – have their foundations deep in classical economics, going right back to Adam Smith’s The Wealth of Nations in 1776. Then, the fear was about an oppressive government – the king – interfering in private trade and wealth creation for his own benefit, rather than that of society.

There have been many iterations down the centuries, but most come back to this: free markets are the most efficient way of creating and distributing wealth; that governments can’t run a sweet shop; that owners of capital will withdraw their money from the economy if the government tries to take over; and that markets are self-correcting.

Some of that is right some of the time. And it’s wrong some of the time. Pretending it’s always right leads eventually to disaster.

But those highly conservative theories dominated the world’s financial systems from the late 1970s until it all blew up with the GFC. In Australia, its last hurrah was Tony Abbott’s and Joe Hockey’s disastrous budget in 2014.

The Washington Consensus was a key product of this period. Formally, it consisted of ten neoliberal policy prescriptions used by the International Monetary Fund, the World Bank and the US Treasury to get debt-laden developing countries out of trouble. It involved privatisations, massive reductions in government spending, deregulation and free trade. And it has widely been blamed – including by many in the IMF itself – of making poor countries poorer and rich countries richer.

But, says Saul, it wasn’t all bad. Free trade has allowed a massive increase in prosperity and led hundreds of millions of people out of poverty. But there should have been much more attention to the inequalities that were produced in many countries, including the rich ones.

“What’s been almost completely neglected is the distribution of those benefits and costs across different parts of society [creating a serious social problem]. And it didn’t have to be the case. And a lot of economists are now demonstrating that rising inequality has adverse impacts on economic growth.

“The social license for the sort of market-friendly policies that business would like has been corroded by the lack of attention to distributional consequences.”


In Australia, scares about government debt-and-deficit were a powerful propaganda tool of conservative politicians like Tony Abbott. Even though Australia’s debt was low and manageable, the slogans about debt crisis and axe-the-tax were as electorally potent as they were damaging to the country.

Now, very similar – though less strident – remarks are coming from the new Labor government.

“The budget is heaving with a trillion dollars in debt,” said the Treasurer, Jim Chalmers. It will take generations to pay down the debt that we’ve inherited.”

So should we follow the politicians’ invitation to worry about excessive government debt?

Not really, says Saul. “There is no principle of economics or public finance which says the optimal level of debt for a government is zero, any more than there is for a corporation.

“I think it’s quite proper for governments to finance longer-term investments that will benefit future generations in part through debt, so that future generations who benefit from it can contribute to the cost. Hospitals, schools, roads.

“In the same way, I think it’s legitimate for some of the costs of dealing with Covid to have been funded by debt. Australia has been somewhat unusual in that there was a period in recent history when the government had no net debt.”

Except for a single year, the United States government has carried debt since 1789, he points out. “And there hasn’t been a day since 1693 – when the Bank of England was founded in part to manage the British national debt – when the UK government hasn’t had some debt outstanding.

“There is no reason to believe that the debt we ran up during Covid needs to be paid off. What I would say, however, is that if we want to be in a position where we can respond as forcefully through fiscal policy as we did in the financial crisis and during Covid, we probably need to aim at having less debt than we currently do, and that we will have in ten or fifteen years time.

“We don’t need to panic about this. We don’t need swingeing cuts in government spending.”

There’s still a live question about whether the Australian government really does have a trillion dollars of debt. The budget earlier this year expected gross debt to have risen to $963 billion by about now. That’s 45% of GDP. But it estimated net debt – what we owe to others, minus what others owe to us – at $729 billion, or 34% of GDP.

But on top of that, the Reserve Bank – itself a branch of government – holds $288 billion of government bonds which it bought from commercial investors during the quantitative easing phase. If we count that – and it’s money the government owes itself – total net debt sinks to $441 billion. In theory, those bonds could simply be cancelled, at a stroke wiping out over a quarter of actual government debt.

It's not so simple, says Saul.

When the Reserve Bank bought those bonds with money it created out of thin air, it created a huge increase on the asset side of its balance sheet but an equally large liability on the other side. That money wouldn’t just disappear if the bonds were cancelled.

Commercial banks – from which the Reserve Bank bought the bonds – park their cash in the form of deposits with the RBA. And those deposits earn interest.

“What governments and central banks have done through quantitative easing is to substitute fixed-rate debt for floating-rate debt. This is very poorly understood.

“If governments issue bonds to the investing public, they are in effect taking out fixed rate loans. If you issue a 10-year bond at two per cent, that rate is fixed [for the life of the bond].

“But the Reserve Bank pays interest [on those deposits] at the cash rate minus ten basis points. Now that the cash rate has gone up to 1.35%, the Reserve Bank is paying the [commercial] banks 1.25%. If the cash rate goes up to 2.5% by the end of this year, which I think it will, then the Reserve Bank will be paying 2.4% per annum.

“People are going to say: ‘Why is the government giving the commercial banks, who make lots of money, all these billions of dollars in interest?’ The answer is that they have a legal obligation to. But at some point, people are going to ask why is that happening.”


Increased taxes, Saul says, are the only real option for the federal government to fund the services the public needs. But which taxes? Who pays?

“I would make sure the people who are on the top rate of income tax actually pay it. There are far too many loopholes for people on high incomes not to pay the amount they would if their income came in the form of wages and salaries.

“It goes back, unfortunately, to the things the Labor Party has walked away from, like negative gearing and the capital gains discount. I can’t think of any valid reason why capital gains should be taxed at a significantly lower rate than applies to wage and salary income.

“While there’s a strong case for tax concessions for compulsory superannuation, they certainly don’t have to be as generous as they currently are.

“A good deal of the money that needs to be raised could come from eliminating loopholes in the personal income tax system that disproportionately benefit the wealthy.

“I think death duties – inheritance taxes – ought to be part of a sensible, equitable and efficient taxation system.

“I’m not opposed to [a super-profits tax for minerals]. But a properly structured royalty regime which takes account of the prices at which minerals are sold could serve the same function as a super-profits tax. Commodity prices are not high because of any great effort by the mining companies.

“Super profits, or rents as economists call them, should be put into a sovereign wealth fund to be drawn on by the government when commodity prices are low.”


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