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.
And no one seems to care, in fact the Gov’t will probably boost spending and therefore debt by Tax cuts and artificially low interest rates justified by a CPI that does not reflect ‘true’ inflation. Refer the following ‘cracker’ thread on M3 expansion:
http://cracker.com.au/viewthread.aspx?threadid=178161&categoryid=11061
By the way a quick description of your views of the relation between the RBA, CPI, M3, and interest rates would be interesting, but probably not that ‘quick’.
Just had a look at the charts seems that Mortgage Debt is the one to blame, business and personal debt similar to 1990. Actually mortgage debt is a HUGE proportion of the problem.
I wonder how that will translate to various sections of the economy, housing effected more than others or will the pain be spread across the land….
May also indicate the amount of home equity withdrawals for spending on non housing stuff!
Should that be “Debtwatch May 2007″?
Mort-gage: could it truely be the penultimate death pledge with reverse mort-gages vacuuming the last equity just afore the popping of clogs?
Whoops! Thanks Fred! I was in a real rush today, and it showed–thanks for spotting the slip for me.
One lecture, two tutorials, one staff supervision meeting, two press interviews, and a media release. Oh it’s great to live the relaxed life of an academic…
Thanks for your understanding, and hopefully tomorrow I’ll have time to incorporate the graphics in this month’s report.
Steve, a question on your household debt (mortgage) vs household disposable income.
How are these measured, australia wide, cost per month, life of loan cost, total mortgage debt……
I can not comprehend that since the mid 90′s mortgage debt has grown from 50% of disposable income to 140%.
I thought repayments were about 30-45% of income, and
interest payment about 9-15%.
Hi Cray,
They’re straight from the RBA Statistical Bulletin, which in turn relies ABS data for the GDP information. Debt is measured and published monthly (by the RBA) and I believe is “full information”; GDP is measured quarterly by the ABS on a survey basis.
Debt values are of accumulated debt; GDP, HDY etc. are quarterly flow figures that are summed on a 4 quarter moving average basis.
The interest servicing costs are numbers I derive by multiplying relevant interest rates by relevant debt measures, and then dividing by interpolated GDP, HDY figures, etc. My figures differ slightly from the RBA’s own estimates that they are now publishing as sheet B21Hist.xls, but not so much that I’m out of the ball park.
From that sheet, the RBA gave the Debt to disposable income ratio as 34.8% in 1977, versus 157.8% today.
Repayments might well be of that scale, but that depends on the aggregate maturity of loans, and I don’t have that data.
It is hard to believe, isn’t it? But that’s what’s happened, and all under the noses of the financial authorities and the government.
Hi Dr Keen,
I stumbled onto your work from iTulip and have spent the last couple of days reading it all instead of doing my work
So the exponential growth of debt and asset values cannot continue forever, that’s a given, and either 1) asset value depreciation occurs (and debt default occurs) or 2) commodity prices increase or 3) a combination of the two eventuates. This all makes sense. Additionally, we have a situation where debt to disposable income levels are historically huge, and debt to GDP is also historically huge.
But the AUD is doing very well, interestingly… Carry trade? Chinese demand for raw materials? Global demand for something other than US treasuries heading to AUD (and NZD)?
Economics can be considered locally, but we’re in a complex, interconnected global system – a fact which we might ignore at our peril. So, getting to the point, a discontinuation of the current situation is possible (likely) to be felt elsewhere, or even originate elsewhere and have effect here. I’m interested in what you might think is a likely outcome for the AUD in the event of such a discontinuation.
My own thought is that interest rates are likely to drop drop drop as the RBA tries to keep things moving, but that this would lead to a fairly decent drop in the relative value of the AUD, similar to what was seen during the Asian meltdown a few years back. And, that this outcome is more likely than the alternative as the AUD is still a minor currency compared to USD, JPY, EUR and GBP.
What do you think?
Hi Ben,
You just caught me as I was belatedly updating the charts page!
Yes, both China and the (Japan) carry trade are behind the high value of the dollar.
As for what happens next… I think that the US housing downturn will turn ugly, and affect Chinese exports to the USA and in turn us. Whether that will bring the Chinese boom in general to a halt, I don’t know. I suspect it will continue on, because just like Japan’s long boom, China’s is fuelled to a large degree domestically–even though export demand played a strong role in starting it, and maintains the balance of trade surplus.
However, the US dollar is likely to plunge when their economy goes into recession; if China’s boom ends at the same time, then our currency will fall with the USA’s (and probably more steeply); if the China boom continues on at a lower level, our currency is likely to hold up compared to the US.
I also expect the RBA to go into interest rate cutting mode. That will of course affect the hedge gambling on our currency, but if the US Federal Reserve is doing the same thing, that will attenuate the devaluing impact from that speculative source.
Whatever though, I think we’re in for extreme global interest rate and exchange rate volatility in the next few years. When it all settles down once more, I think it will in hindsight be seen as marking the end of US economic hegemony and the beginning of China’s.
Thanks Steve for another interesting Debtwatch. I hope you don’t mind me stealing phrases for use in my every-day life? “Things can’t continue as normal, when normal involves an unsustainable trend” concisely sums up the point I’ve struggled (and perhaps failed) to explain in multitudes of lengthy arguments, conversations and writings. Thanks.
The new charts page is great, and while it saves me having to manually create every chart I need for an illustration, I’m wondering whether you could please add a full list of the data sources used for each chart? Perhaps just as a footnote? I’m particularly curious as to the origin of Household Disposable Income. Sorry if this has been explained already. I wonder whether the Household Debt Servicing Burden would be better as “Per cent of Household Disposable Income†where it is currently “Per cent of GDP†(Chart 14 and Chart 19 – there appears to be a repetition of the household charts)?
I’m staggered to see that our current rate of private debt accumulation as a proportion of GDP is at a record level according to the chart. Out of curiosity does anybody know if this rate (>20% per annum) is the all-time record? Gosh, that really would be something special, wouldn’t it!
Go right ahead foundation–since I’m trying to play the role of a Raul Revere here, I’m delighted if anyone else waves the lanterns with me.
On the data sources, all Australian data comes from the RBA monthly statistical Bulletin–which the good folk at the RBA statistical service now provide in a single ZIP file, after a request from me a few months ago.
I then import the data into my favourite analytic program (Mathcad) and then produce the ratios shown in the charts.
Unfortunately I can’t footnote the data automatically in each chart–that’s an option that Mathcad doesn’t support yet–but I will make up a table at some stage explaining how each ratio is derived; and I’ll also provide some numbering of charts (I’ve omitted that to make it easier for readers to cut and paste the graphics into their own commentaries).
You’re right that those two graphs are repetitive–it’s a cut and paste problem. Mathcad generates the graphs in PNG format and gives them randomly assigned names; I have to edit them, and it appears I copied the same graph twice. Hopefully this problem can be overcome in future releases of the program!
I’m not too proud to admit I googled Raul Revere. I’m glad I did, I came up with this gem from a student’s essay:
“One of the causes of the Revolutionary Wars was the English put tacks in their tea. Also, the colonists would send their pacels through the post without stamps. During the War, Red Coats and Raul Revere was throwing balls over stone walls. The dogs were barking and the peacocks crowing. Finally, the colonists won the War and no longer had to pay for taxis.”
http://www.leo.org/information/freizeit/fun/history.html
Many more delicious quotes there. I do wonder about the authenticity of them, but I’ve read some pretty awful essays in my time. Besides, they’re a good chuckle.
Just a quick comment: with all the Budget talk it would be good to get some of the charts out to the public (ABC, print media, etc), especially the ‘change in debt vs change in GDP’ and the ‘mortgage debt to HDI’. To show that the Aussie economy is not all that “Goldilocks”….
By the way a summary of the effect of the Budget on the economy re: interest rates/debt would be interesting, there are a lot of opinions going around at the moment.