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.

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.
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  • cray

    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:

    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’.

  • cray

    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!

  • Fred­Bloggs

    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.

  • cray

    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.

  • Ben

    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.

  • foun­da­tion

    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!

  • foun­da­tion

    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.”

    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.

  • cray

    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.

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