A gaping hole in the Australian economy and what to do about it
Australia has no bond market to speak of. This is a gaping hole in the Australian economy which creates real problems. We could solve the basic problem by next week if we wanted to.
If you’re an Australian company and want to raise a fair amount of cash but don’t want to throw yourself on the mercy of the banks, how do you do it? You go to the ASX and issue shares.
But wouldn’t it be nicer if you could also so raise cash without selling decision making rights in your company? Well unfortunately you can’t do that in Australia. Not easily anyway. There is no bond market to speak of.
This gaping hole in the Australian economy was pointed out in a recent presentation by my colleagues John Mangan and Filip Milosavljevic in the Australian Institute for Business and Economics. I want to try to explain to you why this gaping hole in the Australian economy matters, why it exists, and how the basic problem of creating this market could be solved within a week if we wanted to.
Why does it matter that there’s no Australian bond market?
A bond is really what we call a “securitised” loan. The contract document enumerating the rights to collecting the principle and interest on that “loan” (“coupon payments”) can be sold by the “lender” to another investor at any time.
It’s a really nice way to raise money. The issuer gets money without selling rights to decision-making in their company, and the investor gets the security of having the option to get their money back at any time by simply selling the contract to someone else.
The problem of having no real market to buy and sell these contracts is that it leaves you no real option to raise money within Australia but to turn to the not-especially competitive banks or sell shares. That matters because it makes it much harder to access cheap finance and get an advance on money you don’t currently have to pay for things which need to be paid for now.
That matters in turn because getting an advance on money you don’t currently have is what a functional economy relies on. That’s how we pay workers before the revenues of their labour have been accrued, that’s how we invest in training and machines and infrastructure before their boost to revenue has been accrued. We often have to pay money before we can earn money.
The non-existence of an Australian bond market makes it more difficult for the Australian economy to function. It’s like a river system which irrigates farmland: if part of it is dammed it makes the farmland thirstier than it could be.
Why isn’t there a bond market?
The root cause of our non-existent bond market in Australia is quite plain if we apply the “UQ model” of economic systems: we don’t have a centralised marketplace where bonds can be bought and sold.
It is a classic information problem. The economy is a system which is formed by our actions, our actions are informed by our psychology, and our psychology operates on information. If there is no market when there is need for and desire to hold the products traded in it, when it is clearly feasible and there is strong contract law the only reason for its underdevelopment must be lack of information about opportunities to trade.
You’ll hear many economists (including me) generally rail about the evils of centralisation. But centralisation can sometimes be efficient, and the centralisation of marketplaces is one sometime. There was a reason there used be only one major market square in each town rather than many: it’s more efficient to have one marketplace which aggregates all the information we need to buy and sell. (Critical sidebar — it is important however to expose even centralised marketplaces to competition themselves).
If we don’t have a place where we can access information about very nearly all the bond contracts we might want to enter into we have to rely on our own contacts to discover that same information. We cannot possibly be more likely to discover as many opportunities to trade from our own contacts as from a centralised marketplace.
There is no centralised marketplace in Australia for bonds. Nearly every bond trade in Australia has to occur “over the counter”. If I want to buy and sell bonds I have to go and find and organise willing counterparties myself or know of the existence of a handful of middlemen who could do it for me.
What can we do about it?
The root cause of this problem could be solved within a week if we wanted to and all the government needs do is not interfere.
All it would take is some kid in a residential college taking the technology behind the ASX, or better yet the Trading Post and applying it to bond markets to create a centralised digital marketplace in which very nearly all potential opportunities to trade bonds could be listed to solve the information problem.
This isn’t the complete solution to the problem. But economics is about what to do when you can’t do everything, and we can solve the information problem right now.
There is still the need to provide a means by which the large denominations of bonds can be broken up into smaller parcels. We have to work out what information the government does and doesn’t require to be listed alongside the opportunities for trade (such as credit ratings and other such risk-metrics). Investors need to acquire a “taste” for Australian bonds.
But developing a centralised marketplace for bonds satisfies a necessary condition in the development of an Australian bond market, and moves us one step further to ensuring an even stronger Australian economy.