The Political Debt Cycle

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Both par­ties will make much of their eco­nom­ic man­age­ment cre­den­tials in this elec­tion cam­paign.

Many Aus­tralians, on the oth­er hand, seem con­vinced that the econ­o­my would do as well regard­less of which par­ty were in pow­er.

The aver­age punter has it right: luck, rather than skill, has deter­mined which gov­ern­ments in ret­ro­spect came up smelling like ros­es in the eco­nom­ic man­age­ment stakes, and which instead smelt like manure.

By far the biggest deter­mi­nant of polit­i­cal luck is what was hap­pen­ing to pri­vate debt while any giv­en gov­ern­ment was in pow­er. If debt was ris­ing, then the gov­ern­ment looked good; if it was falling, then the gov­ern­ment looked bad.

How come? Because there are two ways in which you can finance spend­ing: you can either earn the mon­ey, or you can bor­row it. Your total spend­ing in any one year is thus the sum of your income plus the change in your debt. The cru­cial issue is how you spend that bor­rowed mon­ey: if it is being con­sumed or gam­bled, then you will come to grief; if instead you are invest­ing in a busi­ness, or suc­cess­ful­ly spec­u­lat­ing on shares or hous­es, then you can pay your debt off and end up much wealth­i­er than when you start­ed.

The same spend­ing equa­tion applies at the nation­al lev­el, so that aggre­gate demand is the sum of GDP plus the change in total debt. But the con­di­tions under which an increase in debt can be for the good are more restric­tive for the nation than the indi­vid­ual. The coun­try can gain if the bor­row­ing finances invest­ment, but not if it finances spec­u­la­tion.

Investment–building new knowl­edge, new fac­to­ries, new houses–increases the coun­try’s income-gen­er­at­ing capac­i­ty. Speculation–gambling on the prices of shares and houses–just changes who owns what with­in the coun­try; it does­n’t add to aggre­gate income at all. Bor­row­ing for spec­u­la­tion can be good for the indi­vid­ual spec­u­la­tor who sells on a ris­ing mar­ket, but ulti­mate­ly it just dri­ves the coun­try as a whole deep­er into debt.

How­ev­er, in the game of pol­i­tics, that eco­nom­ic dis­tinc­tion does­n’t mat­ter: a spec­u­la­tive dol­lar spent boosts demand just as much as an invest­ment dol­lar. If you hap­pen to come to pow­er when a spec­u­la­tive bor­row­ing binge is on, then you can look like a mir­a­cle work­er, sim­ply by “Being There” at the right time. Woe betide you, how­ev­er, if you take over pow­er just before a binge comes to an end.

This pat­tern is remark­ably obvi­ous in these two graphs: the first plots the actu­al debt to GDP ratio, the sec­ond plots the annu­al change in the ratio. When the ratio was ris­ing faster than trend, the incum­bent gov­ern­ment won plau­dits for great eco­nom­ic man­age­ment; when it was falling, the gov­ern­ment was “eco­nom­i­cal­ly incom­pe­tent”, and nor­mal­ly lost office.

On that front, Whit­lam head­ed the unluck­i­est gov­ern­ment in our his­to­ry. He came to pow­er after the Lib­er­als had been in pow­er for 23 years, dur­ing which time debt was benign for the first six­teen years, and then began to rise in the last eight–making the econ­o­my look bet­ter than it was. The spec­u­la­tive bub­ble real­ly took off a year before the 1972 elec­tion, and just six months lat­er, it burst (see Chart Two).

(I am unable to load graph­ics right now, so click here for the PDF which has the graphs)

Aggre­gate demand took a six per­cent hit, unem­ploy­ment explod­ed from under two to almost six per­cent (see Chart Four), and Whit­lam went down in his­to­ry as the worst eco­nom­ic man­ag­er ever.

Fras­er took over when the worst of the plunge in debt was over, and Aus­trali­a’s long-term debt bub­ble returned to trend. His gov­ern­ment won plau­dits as respon­si­ble if unex­cit­ing eco­nom­ic man­agers, as they mud­dled through the stagfla­tion­ary peri­od after 1975.

Fras­er lost office to Hawke just before the bub­ble accel­er­at­ed once more, and the 1980s boom took hold. Hawke pro­claimed Keat­ing the “world’s great­est trea­sur­er” as the likes of Bond and Skase bor­rowed their way into eco­nom­ic pow­er and appar­ent wealth–only for the house of cards to col­lapse in 1990.

Then, Hew­son real­ly did lose the unloseable elec­tion: Keat­ing hung on to pow­er even though falling debt was slic­ing almost 4 per­cent off aggre­gate spend­ing.

By the time a more cred­i­ble leader was in com­mand of the Lib­er­al Par­ty, and the elec­torate was duly armed with a base­ball bat, Keat­ing lost pow­er. Debt was once again bub­bling along, and it became the good for­tune of John Howard to ride the longest sus­tained upward trend in debt in our history–letting him take the cred­it for “good eco­nom­ic man­age­ment” as pri­vate debt reached unprece­dent­ed lev­els.

What is like­ly to hap­pen after the cur­rent elec­toral con­test? I don’t believe that “busi­ness as usual”–borrowing our way to illu­so­ry prosperity–is pos­si­ble any more. We enter the 2007 elec­tion with the high­est lev­el of pri­vate debt in the nation’s history–twice what applied dur­ing the Great Depres­sion, and one and a half times the pre­vi­ous record, which was set dur­ing the Mel­bourne Land Boom and Bust of the 1880s-90s (see Chart Three).

While it might con­tin­ue grow­ing for a while, there’s no chance that it can con­tin­ue grow­ing for­ev­er. The debt ratio is four times what it was when Whit­lam won office, and cred­it stress is break­ing out around the globe as well. Debt will even­tu­al­ly go into reverse, demand will fall sharply–and the incum­bent gov­ern­ment will be accused of being a “bad eco­nom­ic man­ag­er”.

In real­i­ty, ever since the long term debt bub­ble began in 1964, the eco­nom­ic man­age­ment of both par­ties has been “bad”: with­out being aware of it, they have rid­den the coat-tails of spec­u­la­tors into office and out of it again, all the while let­ting the econ­o­my become ever more depen­dent on debt and spec­u­la­tion.

If we fall into a debt-dri­ven down­turn after this elec­tion, it will not be the fault of the encum­ben­t’s poli­cies at the time–whether it is a Rudd Labor or a Costel­lo Lib­er­al government–but the fault of fifty years of allow­ing spec­u­la­tion to deter­mine both eco­nom­ic pol­i­cy and eco­nom­ic per­for­mance. That is a fault shared across the polit­i­cal spec­trum.

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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.