The Money Multiplier Goes to Work

Everyone talks his own book. But when it comes to choosing between entrepreneurs and politicians, you can guess which ones we put more stock in. Still, what to think of Fortescue’s Andrew “Twiggy” Forrest calling the bottom in the first quarter of this year?

Forrest told the Melbourne Mining Club that, “2009 and certainly this quarter, I believe, will be the bottom of the market.” For everyone’s sake, we hope he’s right. But hope aside, stocks can bottom and still trade in a range for a very long time. It will be the pick-up in Asian demand for key Australian export commodities that drives an earnings recovery for the miners.

Forrest also pointed out that even a big fall in the contract price for iron ore in April would put it back to 2005 levels, which is not a disaster for everyone. But the key is renewed demand. And no one knows precisely when Asian demand for Aussie exports will recover.

It could be a good long while, especially if the demand for Aussie raw materials was driven by American consumption. But then, this is really a conversation about the whole structure of global production and consumption. The old structure has broken down.

Some day this crisis is going to end and the world will look different. The growth of domestic demand in Asian economies will fire up new demand for Aussie exports. But between now and then, a whole army of policymakers, bankers, and bureaucrats will try and preserve the current system.

Speaking of which, how about that $42 billion recovery/stimulus package, or whatever you want to call it? Kevin Rudd and Wayne Swann opened the nation’s check book and dipped into its future earnings with an ambitious plan to…do something.


Moving heaven and earth is beyond the ability of mere mortals. But moving around money, that’s a lot easier, especially when it’s not your own! The plan calls for $12.5 billion in cash and various grants for households. The rest will go into various ‘infrastructure’ programs, although that term-infrastructure-is being used rather liberally these days.

So will it work?

Well, it depends on what you mean by ‘work’? In a purely political sense, giving people more of their own money always makes them feel better. And in principle, we’ve never met a tax cut we didn’t like.

Giving people who don’t pay a lot in taxes even more money is even more popular. So in that sense, the arrival of thousands of dollars in government cash to various Aussie households will ‘work’ in the sense that it distracts people from the ongoing disaster that is the world financial crisis.

“Look honey! Free bread. Let’s go to the circus!”

Please note that shuffling a bit of cash around will not lessen a national debt-to-GDP ratio of around 140%. Nor does it do much to create long-term jobs. But hey, who isn’t impressed by a little walking around money?

What about the rest of the plan? That is more complicated. There is a stupid belief that spending money on ‘shovel ready’ infrastructure projects is a great way to get the economy going right now. That’s probably not true. That’s not to say the infrastructure projects aren’t necessary, or good long-term investments. But they may not be the sort of thing that gets money sloshing around in the economy post haste. Why?

The money multiplier. How quickly does each new dollar of spending turn into even more lending and spending in the economy? If you put cash in household hands through grants or tax cuts, household spending makes it into the economy pretty quickly.

You buy an air conditioner. You buy a lawn mower. You buy a steak dinner. You buy a bottle of Bombay Sapphire Gin. You go to the pokies. No matter what you do, the cash is in the hands of the people in the trenches and on the front lines of the economy. These bullets are probably going to get fired.

Each dollar that changes hands starts “stimulating” other spending. Don’t get us wrong. In the long term, stimulating consumption with hand-outs does nothing to build capital assets for a nation. It gives the illusion of activity. But the activity is for its own sake. It doesn’t build wealth, it just stirs it around.

The question with infrastructure spending is whether the multiplier works at all in the short-term. Does each new dollar of government spending on infrastructure correspond to three, four, or five dollars of new consumption in the economy? Or is the ratio much more modest?

We don’t know. Different people say different things. Economists Susan Woodward and Robert Hall studied the effects of government military spending on GDP growth in World War Two. They concluded that each new dollar of government spending led to a $1 in GDP growth, or a ratio of 1:1. That’s not exactly a big multiplier.

On the other hand, Christina Romer suggests that each new dollar in tax cuts raises GDP by about three dollars. Why that is exactly isn’t clear. And it’s by no means a settled point among economists that tax cuts have a bigger multiplier than government spending.

For example, Paul Krugman thinks that equating military spending with infrastructure spending and then measuring its effect on an increase in GDP is theoretically flawed because rationing limited consumption in World War Two America anyway.

It’s all a bit of a red herring anyway. Spending money for the sake of spending money doesn’t make anyone richer. It’s an artificial boost to demand that belies a host of other underlying economic conditions which are, frankly, awful.

It would be an interesting debate if you conceded that infrastructure spending provides no immediate boost to consumption or GDP, but that we should do it anyway because the projects are necessary to the long-run health of the economy. This is the “Nation Building” argument.

The trouble is, you then get into argument over what kind of nation you want to build. Are you talking bridges, roads, ports, and rails-real physical infrastructure that greases the wheels of commerce and transport and improves quality life over time? Or are you talking education, broadband networks, healthcare and other programs? How do you measure the return on investment for those sorts of things?

In one case, you have an argument that there are certain projects-because of their long-term nature, capital cost, and low investment returns (but high social returns) that ONLY the government can do. This is purely an economic argument. In the other case, you get an argument that there are certain things, in a civilised compassionate society, that the government OUGHT to do. This is purely an argument about what the proper role of government is in building a fair and just society.

Kevin Rudd’s job will be to blur the distinction between the two and spend as much as possible while everyone remains confused and scared. To do this, Australia’s government is going into deficit. It will be around $22.5 billion to begin with. That’s just above 3% of GDP.

In Japan, decades after asset deflation besieged the economy, public sector debt is well over 100% of GDP. But don’t worry. All in due time-if there is enough money in capital market to provide for that much government borrowing, while still meeting the borrowing needs of the private sector.

More reader mail?


I do enjoy your interesting and informative articles, and generally give them a lot of credit for being informed and substantial.

Today I was shocked to see – being an Austrian, living in Australia, that you gave Ludwig von Mises a different nationality. Ludwig von Mises, one of the major theoreticians on economics last century lived and worked in Europe, he was Austrian by birth and not Australian. Australia is only just now waking up to the vagaries of economic theory, having slumbered for most of its existence in the relative safety of a society buoyed by agriculture and mining. Lucky are those who manage to live here!

Please correct this!

Consider it corrected and accept our humblest apologies. We make mistakes from day to day in our frantic pace to get the DR out on time, and yesterday was one of them. For the record, von Mises was Austrian, not Australian. And he stands with Friederich Hayek, Joseph Schumpeter, Henry Hazlitt, Frederic Bastiat, and Murray Rothbard in our pantheon of economic heroes.

Here’s another.

Hi there!

In your newsletter dated Feb 2 “A $4 Trillion ‘Big Bang’ – you cite Marc Faber saying “”I’m not optimistic about the global economy,” says our old friend, Marc Faber. “The next Madoff case – the next Ponzi scheme – is the U.S. government. It will go bust. It is only a question of time.”

I was discussing this comment with a couple of friends – can you please share your view on how the US Government can go broke. After all, the US Government is not a bank by definition. I understand how a Central Bank can fail (and has done in the past) – but how can the US Government technically go broke?


Adrian (Sydney)

As long as the U.S. government enjoys the privilege of borrowing money in the currency it also prints, it can never, technically, go bankrupt. The Treasury can issue new bonds and the Fed can buy them with new dollars. This would naturally have a negative effect on the value of all the other dollar-denominated claims outstanding. But in theory, the U.S. never has to default on its bonds.

Insolvency implies that your liabilities exceed your assets, and that is certainly true for the U.S. government. Its liabilities increase by leaps and bounds each day. Its assets? Well those are tax revenues. But as long as it can pay off its liabilities with new money, it can technically forestall insolvency.

In practice, the day is coming when the foreign capital markets are unlikely to gobble up U.S. Treasury bonds. You’re going to see a Treasury auction fail before this all over. It will fail because the U.S. is about to spend $1 trillion on a grab bag of various projects selected to please political allies and local constituencies, while doing nothing effective to clear up bank balance sheets of non-performing assets that are eating away at equity capital.

Once the world gets a look at how the U.S. Congress spends borrowed money, we reckon it will be curtains for the days of limitless U.S. borrowing on global capital markets. In this sense, the U.S. cannot continue to spend more than it takes in through revenue and make up the difference with borrowed money. Its borrowing costs will go up and it will be forced by its creditors (China and Japan) to live within its means.

And one more note on collapsing Asian trade. This is the real obstacle any Aussie recover plan must overcome. And honestly, how is $42 billion of spending and household insulation going to insulate us from the kind of economic downturn this reader describes bleow?

Hi DR, I am an avid fan and daily reader of your publication.

I am an Australian living Singapore and can assure you, your pictures don’t do justice to the floating parking lot off the coast of Singapore. In recent months the number of cargo ships parked in the straits has exploded. It has been an economic indicator I have kept an eye on. The best angle to get a photograph from would be from the East Coast Park just before and after dusk. The ships leave there lights on and it looks like a floating city just off the coast. I recently went to the east coast to watch the Volvo Ocean Race which put on an ‘in harbour’ race as they passed Singapore. They almost didn’t have enough room left in the harbour to hold the race.

I would happily get you a picture or two, but am travelling in Hong Kong & Taiwan for the next few weeks. Keep up the great work, a little less ‘banging on’ about the future of gold prices would be nice. We heard you the first dozen times!!



Dan Denning
for Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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18 Comments on "The Money Multiplier Goes to Work"

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Coffee Addict
This is what Michael J Knox of ABN AMRO Morgans says about the Rudd Package in their 4 February Report. “The Obama stimulus package has a multiplier or bang for the buck of around 1. This means that there is around $1.00 of GDP added for each $1.00 of stimulus spent. The Rudd stimulus package seems to have a much lower multiplier of 0.3 in its first year and no more than 0.6 in its second year. The multiplier is much lower because the Rudd package chooses to spend its money on social infrastructure rather than economic infrastructure. In terms… Read more »
greg the farmer
good site! Bill,you have eluded to this a few times…..Where is all this borrowed money comming from. The USA is about to borrow a trillion. Kevin07 is about to issue another $A50b.UK/EU/Iceland. Wesfarmers goes to the market last weekend for a massive capital raising. Qantas announces today another half billion. Surely the smarties in China/Japan/Saudi must be thinking twice about taking up USA paper at any price, let alone yields of 0%…..Particularly as the ultimate fallback to repay is to print? In short are we about to see a rapid “black swan” shift from sovereign paper into gold or…..? I… Read more »
A significant part of infrastructure funding is on schools australia wide, which hopefully puts some money into all communities including country towns and rural area and may help them survive. I happen to think that is well targeted. The multiplier effect is an imprecise thing to accurately measure.Not sure what they use, but hope it includes social costs of saving some small commumities. We still want to live in communities and some of us value the social structure, which our representitives have to consider in the equation.How anyone knows the multiplier effect in the USA already without knowing if the… Read more »
Greg Atkinson
Coffee Addict, you are spot on. If the government has to spend billions then they need to do it with a sense of purpose. The aim is not just to cushion the economy, but to help the economy meet future challenges. Back in December I was ranting about this in a blog article called “Actions to stimulate the economy in 2009 and beyond” in which I argued that money should be spent supporting companies and other measures that would help Australia over the long term. Rudd and Co. are incompetent and I say this with justification, because if they were… Read more »

Asynchronicity would be a good word if that were to be the centre piece of a strategy in the face of a conflagration. But beyond the rhetoric there isn’t enough force to give anything a real shove yet there is more than enough for everyone to take notice of the desperation. Work out how we will go from one day to another limited to just restraining household debt and yet sustaining the services economy we have built and then go back tactical strategy.


In southern Australia where we’re burning up in climate change (according to the Bureau of Meteorology) induced heat waves and suffering power shortages – insulating all the buildings IS decent infrastructure spending. It will also supply employment to a fair slice of those mining workers and construction tradespeople about to be laid-off as the orders from China, Sth Korea, Japan etc dry up.

Greg. I seem to recall the reserve bank was putting up interest rates for a few years to actually take the heat out of the housing market whilst credit was being thrown around,and try to have a soft landing when the inevitable happened. They recognised a bubble and the interest rates were to counter that asset inflation. Inflation was a concern.They did better that USA. Interest rates were a blunt instrument and probably went one hike too far,but inflation was the priority and trying to keep the bubble under control.All the experts (and I mean all)warned Rudd and Swan not… Read more »
Pete's going to throw a shoe
Pete's going to throw a shoe

Peter Costello is on to it in his latest interview on Rudd’s deficit and Rudd’s Essay – just bizarre. Here he is on lateline: just scroll down and you’ll see his picture.

I can see a shoe being thrown from the back row of the opposition towards Rudd soon. This shoe throwing cracks me up!

Keep up the great website. Regards to the team.

Thanks for a great read – Your site is one of the few I visit on a daily basis. If the package increases debt to $200 billion, what possible actions can Rudd and Co take when unemployment rises significantly?

Greg Atkinson
Gerry, I think the problem we always have is RBA versus government policy and the two are not always in sync. I do not blame the RBA for raising rates but I do blame them for raising them too far in 2008 and then not bothering to meet in January 2009. But to be fair to the RBA, it is hard to cool housing when both sides of politics are trying to stimulate demand via first home buyer grants and immigration. I agree with your comment about interest rates being a blunt instrument, they certainly are. I was also not… Read more »
rick e

Also when raising interest rates at that time people fixed the interest rates for 2 + < years at around 6.5 % + < in case it went higher

It reminded me when(home fund) the interest rates went up to 18% and then st George came out and offered 15% fixed (alot of people got in) and then a few months later it drop to 10% then it kept going down.

So there is two ways to look at why the RBA raised and then dropt interests rates.

The Outback Oracle
Why is everyone ignoring the External account in all this? We are a Debtor nation. We have run CAD’s for 50 years…continuously except for 1971 (I think it was). The last few years under Howard and Costello,our international debt grew parabolically even in the face of the highest commodity prices the world has ever seen. We owe some $700,000,000,000 (Yeah a 700 with a heap of zeroes …$700Billion dollars) Access Economics predicts the CAD to grow to $100 Billion annually with the slump in commodity prices. That was without this latest $42B of debt being added to the economy. We… Read more »
Coffee Addict

Oracle. The answers are complacency, laziness, fatalism and a belief that God would not let it happen to me and my family. Many welfare recipients (older pensioners excepted) sit with a view along the lines Don’t Know, Don’t Care, “Canberra’s” fault” & Don’t Affect Me!

Attitudes in many debtor nations are, I guess, much the same. Following a generation or three on the easy credit gravy train I’m not surprised.

My guess is that Rudd and Turnbull understand exactly what you are saying. However they both elect to keep their true thoughts private.

Oracle and CA: I agree with your points. One reason I think we are oblivious to the long-term damange is that Australia, the US and other debtor nations are short-termists – we only think a few years ahead. This is one reason we think 100% loans on 30 year mortgages is okay, because we don’t consider the longer term costs (a life of debt servitude). Think about all the things that contribute to our short-term desires: credit cards, ’18 months interest free!’, equity withdrawals on mortgages, easy finance car loans, first home buyers grant…i’m sure there are more Conversely, nations… Read more »
The Outback Oracle
Yes Pete But, since this stimulus was announced, I’ve avidly listened to, and watched, Current Affairs programnes, listened to representatives of business groups, Analysts, Economists, and I am yet to hear one public comment that expresses any apprehension because of our parlous external account situation. Not one!!! Even Gerard Minack seems to have deserted me!!! Ah sorry…Michael West at SMH is doing the best he can! Yes i think Turnbull knows…..Yes i think Rudd knows and Wayne Duck..and Ken Henry…they all know. So it means that they are prepared to sacrifice anyone and anything including the welfare of this nation… Read more »

Aha…the thing with politicians is…they hate ‘risk’

But is it not a risk to kill Australia’s future?

That is not the risk I am talking about – I am talking about risk of blame and accountability.

Politicians will go with what the ‘experts’ say and what other countries are doing, because then they can shift the blame to someone else. They’re so good at doing that.

Any politician that takes blame is in real trouble….they often get asked to resign.

What we need is real leadership.

What we get is politicians (who are unfortunately selfish).

Coffee Addict
Some Bushfire Recovery Stimulus is Needed! We should ALL lobby Bob Brown, Steve Fielding and Nick Xenophon TODAY to vote against the Rudd stimulus package as it stands. The multipliers for Rudd’s “give aways” are so low that not even the Keynesians support them. You should email the pollies in our own words and with our own logic so I don’t need to say much more. Except to note there are now thousands of “shovel ready” agricultural and economic infrastructure reinvestment projects waiting to go in Victoria which possess far better multipliers Rudd’s X Box/ flat screen TV/ pokie /… Read more »
Dan, how close could we come to reaching a multiplier conclusion achieved on $1 of foreign debt to GDP, uninsured (or phoney risk rated to achieve negligible CDS cost), and applied exclusively to asset price appreciation to grow consumption wealth? The downstream given would be an application of funds in the services economy and where productivity in the general economy is otherwise flatlining or going backward. My bet is that the figure would dwarf anything with any prospect of being marshalled by way of countervailing stimulus. And if so that would bring Andrew Mellon back front and centre.
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