Debtwatch May 2007: Booming on Borrowed Money

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It goes with­out say­ing that I’m a Cas­san­dra amongst the Pollyan­nas crow­ing about Aus­trali­a’s cur­rent eco­nom­ic per­for­mance data. Low infla­tion, low unem­ploy­ment, and no sign of a wages break­out, are the usu­al­ly-quot­ed sweet eco­nom­ic indi­ca­tors (admit­ted­ly with some strange bed­fel­lows, includ­ing a rel­a­tive­ly slow rate of eco­nom­ic growth for these con­di­tions, and a huge bal­ance of trade deficit despite the best terms of trade in his­to­ry).

So how do I jus­ti­fy the stance of a Cas­san­dra? Because things can’t con­tin­ue as nor­mal, when nor­mal involves an unsus­tain­able trend in debt. At some point, there has to be a break–though tim­ing when that break will occur is next to impos­si­ble, espe­cial­ly so when it depends in part on indi­vid­ual deci­sions to bor­row.

How­ev­er, it is pos­si­ble to quan­ti­fy the min­i­mum impact that the end of the unsus­tain­able might have on the econ­o­my: what would hap­pen to aggre­gate spend­ing if pri­vate debt grew no faster than GDP?

Aggre­gate spending–on both com­modi­ties and assets–is the sum of incomes plus the increase in debt. Using GDP as the mea­sure of income, this was $1,001 bil­lion in the last cal­en­dar year. Over the same peri­od, pri­vate debt increased by $202 bil­lion. Aggre­gate spend­ing was thus approx­i­mate­ly $1,200 bil­lion. Pri­vate debt grew by 14.9 per cent in the last year, ver­sus a 7.4 per cent growth in nom­i­nal GDP.

If both pri­vate debt and nom­i­nal GDP were to grow at the same rate as GDP last year, then GDP next year would be $1,075 bil­lion, while debt would rise by $115 bil­lion. Aggre­gate spend­ing would thus be $1,190 billion–or $10 bil­lion less than spend­ing this cal­en­dar year.

In one sense, we are now so much in debt that we can’t afford not to con­tin­ue bor­row­ing. And yet the more we do bor­row, the more severe the shock will be to aggre­gate demand when the cor­rec­tion final­ly occurs.

This sit­u­a­tion has come about because of the expo­nen­tial growth in debt rel­a­tive to GDP. Back in 1963, when debt was just 25 per cent of GDP, a fall in the rate of growth of debt had only a minor impact on demand. Now, with debt equiv­a­lent to 153 per cent, that small effect has become a very big one.

So my Cas­san­dric pes­simism is not entire­ly based sim­ply on dis­po­si­tion. At some point, the debt to GDP ratio must stabilise–and on past trends, it won’t stop sim­ply at sta­bil­is­ing. When that inevitable rever­sal of the unsus­tain­able occurs, we will have a reces­sion.

Just the Facts, Ma’am…

To be con­tin­ued after I fin­ish this morn­ing’s lec­ture… In the mean­time, for most of the charts that will appear in this report, please go to the Charts page of this blog.

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About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.