1Q2012 Government Debt Update

With the fiscal deficit still with us, government debt continued to increase in 1Q2012 (RM millions):

Gross issuance reached RM24.7 billion, with redemptions totalling RM9.3 billion. As a result, net government debt increased by RM15.5 billion in 1Q2012, a marginal increase over 4Q2011, and total debt reached RM470.8 billion.

US Ratings Downgrade: The End Of The World Is Nigh! Again

I hadn’t touched a computer since last Friday, so I only heard the news Monday morning. While S&P’s move was a bit of a surprise, coming as it did on the heels of the agreement last week on the US debt ceiling, it wasn’t an absolute shocker. The magnitude of the US national debt – and more importantly, who’s holding it – suggests that the risk was always there.

Fundamentally though, nothing has really changed since last week or last month. I can’t help feeling that the ratings agencies are bolting the stable door after the horses have fled. They were roundly criticised and partly blamed for the CDO mess that caused the liquidity crunch in 2007-2008 – both in rating structured products at AAA grades as well as for failing to downgrade fast enough when it became clear that most of the stuff was junk. This is perhaps S&P’s way of saying never again, as the downgrade is a bit of a paper tiger.

What makes this all ironical is that because US government borrowing is all denominated in US dollars, the risk of default is effectively zero. Hence, I don’t know if there’s going to be any real impact on US debt issuance or investor appetite for US treasuries. Even as equities worldwide faced a sell-off, when I checked just now – as I suspected would happen – US treasury yields were down, not up as you would expect on a ratings downgrade. The news just provided investors an excuse to act on their fears over global growth, as equities have looked overbought to me and many others since early this year.

But flight to safety leads directly back to US sovereign debt. So you’ll have this paradoxical situation of the debt downgrade leading to higher demand for the very debt that supposed to be less credit worthy (and incidentally, higher demand for the USD). Go figure.

And before anyone starts blaming the Fed for treasury price movements, let’s note that QE2 ended last month and hasn’t been extended (yet). I’ll also note in passing that the ECB took the opportunity today to quietly expand their QE program, adding in Spain and Italy to the existing support they’ve extended towards Greek, Irish and Portuguese debt.

We’re truly living in interesting times.

Why Individual Income Tax Cuts Won't Boost The Malaysian Economy

Now that the mini-budget has a date (March 10), speculation is increasing regarding what's going to be part of the stimulus plan. One idea that continues to be popular is the personal income tax cut - but as this article argues, the effect might be very small relative to the revenue loss to the government. In other words, there are better uses of the money that might have a greater impact on the economy. I find the line of argument a little confusing though - what the heck does "taxpayers’ role is a small proportion of the total labour force" mean?

Leaving aside the Laffer curve controversy (see:Reagonomics or Bushinomics), there's a very strong argument against using tax cuts to support economic growth. If, as the case should be here, the tax cuts (or rebates as the case may be) are expected to be temporary and will be lifted after the crisis, then rational economic agents would treat any such income as a windfall and save it rather than spend it. This means there would not be any boost in aggregate demand.

In real life, people aren't always fully "rational" in the economic sense - some of it will be spent, even if such spending is not logical and does not maximise utility. This was clear from the first Bush fiscal initiative just after the onset of the crisis, where there was a mini-boost to the economy in mid-2008. Nevertheless the boost was very short-lived, indicating possibly weak multiplier effects and reflecting the fact that the stimulus didn't resolve the underlying structural problems in the financial system.

Another issue with tax cuts is that it will only affect those who actually pay taxes. While I don't have the figures with me, my personal tax experience suggests that the lower-income group will receive little if any benefit from a cut in marginal rates. Unfortunately, this would be the group that would be most effected by the slowdown in growth, and need the most help. I'm thinking this effect is what the article meant by "narrow role of the taxpayer".

More to the point, a 1%-2% cut in personal income taxes won't actually release much money into the economy - at least relative to the stimulus required. Individual income tax only amounted to around RM12 billion in 2007, and under RM16 billion in 2008 for the first three quarters (much less than half of the take from companies). A 2% cut might put in RM1 billion into the economy, most of which would likely be saved. Remember that a cut in the rate effects mainly the top marginal rate, not the tax brackets necessarily. I'm doubtful whether a change in the tax brackets themselves might be effective either.

I'm more of the view that fiscal expenditure would probably be more effective, but that's a post for another day.