Swan’s “responsible” budget surplus promise is starting to look irresponsible: Kohler

The Government’s “responsible” strategy of returning the budget to surplus in 2012-13 is beginning to look irresponsible instead.

Getting from a near $50 billion deficit in 2011-12, which is what the leaks have been preparing us for in next week’s budget, to a surplus a year later would require a huge surge in growth and tax revenue over the next two years, which is not going to happen.

Treasurer Wayne Swan needs to dump the surplus promise as soon as possible; the alternative is either a nonsensical budget strategy or a damaging one, as spending is cut and taxes raised to meet a fabricated political target.

What’s changed is the currency. It is now virtually $US1.10 and there is a clear risk that it will go much higher over the next year or two, albeit with corrections along the way.

This represents a huge difference with the first leg of the mining boom between 2004 and 2007. Then, the average exchange rate was 78 US cents, which underpinned a $300 billion blowout in tax revenues versus budget forecasts.

This time around there are two negatives to deal with: first all profits are being hit hard by the exchange rate; and second the investment boom, which has taken a few years to get going, is producing a massive increase in depreciation deductions.

TD Securities reports that over the past decade the mining sector has accounted for 20% of corporate profits but only 10% of company tax revenue. With capital expenditure forecast to grow 36.7% in 2011-12 according to the ABS, this gap is only going to widen.

The revenue shortfall will be worsened by a rising exchange rate over the next two or three years as the United States approaches an inevitable fiscal crisis.

US government expenditures are currently 25% of GDP, according to the Congressional Budget Office, and revenues are 15%. To close this gap the US needs a growth surge or a massive sustained cut in government spending, or both. Neither is in prospect.

With the House of Representatives controlled by the Republicans, and the Senate and White House controlled by Democrats, nothing will be done until after the 2012 election. And unless the President has won that election by campaigning on spending cuts (unlikely) and therefore has a mandate for them, nothing will be done after the election either.

A fiscal crisis and debt downgrade for the United States of America would be much worse than for Greece or Portugal. That’s because 30% of its Treasury debt is held by foreigners, largely central banks and largely China, and there is no one to bail it out.

Moreover, the US has been running current account deficits for years and is now up to a cumulative total of $US8 trillion.

US debt held abroad is highly liquid and vulnerable to either panic selling or deliberate shorting. That’s particularly so with US bond yields held artificially low by the so-called safe haven effect, which could disappear quickly.

The bottom line is that having declined 20% in a year on a trade weighted basis, the US dollar remains vulnerable to a crash. It will be bolstered by the end of Federal Reserve monetary stimulus in June, but that is likely to be short lived.

The Australian Government should be planning for an exchange rate much higher than $US1.10 and that means lower GDP growth and less tax revenue.

In the circumstances, cutting spending and raising taxes to meet an artificial and unnecessary promise to report a surplus in 2012-13 would be incredibly irresponsible, especially at the same time as adding a carbon tax.

This article first appeared on Business Spectator.