Just two years ago, Central Banks appeared triumphant. Inflation, the scourge of the 1970s and 80s, appeared dead, the financial crisis of the Tech Wreck had been contained, economies worldwide were booming, and stock markets and house prices were spiralling ever upwards.
Then along came the Subprime Crisis, and we received a rude reminder of why Central Banks were created in the first place: to ensure that the world would never again experience a Great Depression.
We are not in a Great Depression–not yet anyway–but a key pre-condition for one has developed right under the noses of Central Banks: excessive private debt. In fact, debt levels today are twice as high as in 1929, which is why this financial crisis is causing far more carnage than 1929 did.
At the time of the Stock Market Crash of October 1929, the US’s debt ratio was 150%; today it is 290%. Australia’s ratio was 64%; today, it is 165%. The regulators who were supposed to keep us from the jaws of The Beast have instead led us closer towards its belly.
Figure One
USA and Australian Debt to Output Ratios 1920-2008
This was not, of course, a conscious decision. It has happened because Central Banks are run by economists, and the dominant “Neoclassical” faction within economics ignored the real lessons of the Great Depression.
The false lesson that Neoclassical economics preaches is that the market economy is fundamentally stable, and the Great Depression was caused by the monetary authorities tightening credit in the aftermath to the Stock Market Crash, rather than loosening it.
The real lesson of the 1930s is that a credit-driven market economy is fundamentally unstable, and a Great Depression occurs when debt-financed speculation results in excessive private debt at the same time as inflation is low.
Central Banks, under the misguidance of conventional economic theory, ignored the role of private debt in the economic system. They instead reinterpreted their charters–which emphasised full employment–as a mandate to keep inflation low.
As the RBA put it in its most recent Annual Report, its:
“duty … to ensure … the stability of the currency… the maintenance of full employment … and the economic prosperity and welfare of the people of Australia… has found concrete expression in the form of a medium-term inflation target. Monetary policy aims to keep the rate of consumer price inflation at 2– 3 per cent, on average, over the cycle.” (Annual Report 2008, page 5).
With its Neoclassical eyes fixated on the rate of inflation, it ignored the expansion of private debt–as did its equivalents at Central Banks around the world, as did government Treasuries, and as did international economic agencies. This is why the sudden collapse of the world economic order took economists by surprise. They were looking at their mathematical models, which ignore private debt (and indeed money!), rather than at the real world, where debt is king.
Nowhere was this more obvious than with the OECD–the organisation whose imprimatur the Australian Treasury seeks. The following are the unabridged opening two paragraphs from the Editorial to the OECD Economic Outlook from May of 2007 (with the really funny bits in bold):
“In its Economic Outlook last Autumn, the OECD took the view that the US slowdown was not heralding a period of worldwide economic weakness, unlike, for instance, in 2001. Rather, a “ smooth” rebalancing was to be expected, with Europe taking over the baton from the United States in driving OECD growth.
“Recent developments have broadly confirmed this prognosis. Indeed, the current economic situation is in many ways better than what we have experienced in years. Against that background, we have stuck to the rebalancing scenario. Our central forecast remains indeed quite benign: a soft landing in the United States, a strong and sustained recovery in Europe, a solid trajectory in Japan and buoyant activity in China and India. In line with recent trends, sustained growth in OECD economies would be underpinned by strong job creation and falling unemployment.”
Yeah, right. Just three months later, the financial crisis began.
It should by now be painfully obvious that conventional economics cannot be relied upon to explain where we are, how we got here, where we might end up, and what might work to avoid the worst consequences. To understand it, we have to go back to the economist who got it right, but was ignored by the economics profession: Irving Fisher.
The Debt-Deflation Theory of Great Depressions
Fisher had been an academic cheerleader for the financial bubble of the Roaring Twenties–his main claim to fame one can find on the Internet is that he uttered the fateful prediction that “Stock prices have reached what looks like a permanently high plateau” the week before the Stock Market Crash of 1929.
Four years on, chastened and effectively bankrupted, he reflected that a Great Depression ensued when too much debt was accompanied by falling prices. He christened the phenomenon a “debt-deflation”.
A key aspect of Fisher’s reasoning was that, though economists of his time modelled the economy as if it were permanently in equilibrium, the real economy would always be in disequilibrium. As he put it, even if the economy did tend towards equilibrium:
“ new disturbances are, humanly speaking, sure to occur, so that, in actual fact, any variable is almost always above or below the ideal equilibrium”
He also argued that the forces that gave rise to a Depression were innately disequilibrium in nature. The two key factors that caused a Depression, he argued, were excessive debt and falling prices. Though other factors might lead to a crisis (such as overconfidence or excessive speculation), debt and deflation were the two key forces that turned a garden-variety downturn into a Depression. As he very poignantly put it (since he himself was a victim):
“over-investment and over-speculation are often important; but they would have far less serious results were they not conducted with borrowed money. That is, over-indebtedness may lend importance to over-investment or to over-speculation. The same is true as to over-confidence. I fancy that over-confidence seldom does any great harm except when, as, and if, it beguiles its victims into debt.”
Fisher then laid out the sequence of events that follows when a financial crisis ensues in the context of excessive debt and low inflation:
“(1) Debt liquidation leads to distress selling and to
(2) Contraction of deposit currency, as bank loans are paid off, and to a slowing down of velocity of circulation. This contraction of deposits and of their velocity, precipitated by distress selling, causes
(3) A fall in the level of prices, in other words, a swelling of the dollar. Assuming, as above stated, that this fall of prices is not interfered with by reflation or otherwise, there must be
(4) A still greater fall in the net worths of business, precipitating bankruptcies and
(5) A like fall in profits, which in a “capitalistic,” that is, a private-profit society, leads the concerns which are running at a loss to make
(6) A reduction in output, in trade and in employment of labor. These losses, bankruptcies, and unemployment, lead to
(7) Pessimism and loss of confidence, which in turn lead to
(8) Hoarding and slowing down still more the velocity of circulation. The above eight changes cause
(9) Complicated disturbances in the rates of interest, in particular, a fall in the nominal, or money, rates and a rise in the real, or commodity, rates of interest.”
After the Crash of 1929, when business debt was dominant, many firms found themselves with debt repayment commitments that they couldn’t meet out of cash flow. They undertook “ distress selling” to try to raise the money they needed— and because everyone dropped their prices, prices fell across the board. Even firms that managed to pay their debts down in nominal terms found that their revenues fell even more than their debt, leading to “ Fisher’s Paradox” that:
“the more debtors pay, the more they owe. The more the economic boat tips, the more it tends to tip. It is not tending to right itself, but is capsizing.”
That phenomenon is strikingly obvious in the historical data, which shows the rate of inflation falling from trivial levels (of between 0.5% and 1% p.a.) to minus 10% p.a. between 1931 and 1933.
Figure Two
Inflation Rates 1920-40 USA and Australia
Economic growth also came to a shuddering halt as the ensuing credit crunch cut spending levels, and as cash-strapped businesses sacked their workforce. That decline is also evident in the data, with the rate of real economic growth falling from 6% before the crash to minus 8% after it–and as low as minus 13% in 1932.
Figure Three
Rate of Economic Growth 1920-40, USA and Australia
The decline in both output and prices meant that the debt to GDP ratio continued to rise after the Stock Market Crash of 1929–even though credit was tight, and anyone who was in debt was trying to reduce it. Notice on Figure One that debt ratios continued to rise until 1932–from 150% to 215% of GDP in America, and from 64% to 77% of GDP in Australia.
The effect of this decline on employment was so severe that it has remained etched into humanity’s psyche. When the Stock Market began its collapse, the level of unemployment in America, as recorded by the National Bureau of Economic Research, was 0.04%–one 25th of one percent. Three years later, it reached 25%. Australia’s unemployment rate blew out too, from a higher initial level of 9% to a peak of 20% in 1932. The world had suddenly moved from The Great Gatsby to They Shoot Horses, Don’t They?
Figure Four
Unemployment Rates 1920-40, USA and Australia
This calamity, which economic theory said could not happen, both discredited conventional economic thought, and gave credence to the then unfashionable views of John Maynard Keynes (Fisher, with his reputation in tatters after his false assurances that nothing was amiss in 1929, was largely ignored–even though Fisher’s explanation of how Depressions occur was superior to Keynes’s). When the world emerged from the World War that followed the Great Depression, so-called Keynesian Economics dominated the profession, and the once supreme Neoclassicals were ignored.
However, one of the most prophetic observations that Keynes ever made concerned the likelihood that his new ideas would fail to be truly accepted by the economics profession. In the Preface to his General Theory of Employment, Money and Wages, Keynes observed that:
“The ideas which are here expressed so laboriously are extremely simple and should be obvious. The difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds.”
So it proved to be. Though calling themselves “Keynesian”, most academic economists continued to cling to the preceding “Neoclassical” ideas (especially in the area of microeconomics, which Keynes did not address).
As the experience and the memory of the Great Depression receded, academic economics produced a hybrid of Keynes’s macroeconomic ideas grafted on top of Neoclassical microeconomics that they called “the Keynesian-Neoclassical Synthesis”.
Unfortunately, the ideas were incompatible–and over time, wherever there was a conflict, academic economics rejected the Keynesian graft, rather than the underlying Neoclassical microeconomics. After fifty years of this, Keynes’s ideas were completely ejected from the economic mainstream, the Neoclassical belief that the economy is self-correcting became dominant once more, and economists trained in this belief came to dominate Treasuries and Central Banks around the world. They ignored levels of private debt, championed deregulation of finance, and virtually encouraged asset price speculation.
Now we have twice as much debt as caused the Great Depression, and inflation so low that, were it not for unprecented factors (the rise of China, global warming and peak oil), deflation would almost be a certainty.
Having thus unlearnt the real lessons of the Great Depression, the economics profession may yet make us relive it.
END OF COMMENTARY
Comments on the Data
It appears that Australia’s debt to GDP ratio has peaked at 165% of GDP. It could still turn up once again if deflation takes hold, but for the meantime, this seems to be the top of the bubble.
Now as debt levels start to fall–firstly relatively to GDP and then, ultimately, in absolute terms as well–the macroeconomic effect of the bubble’s bursting be felt.
This is because aggregate demand is the sum of income plus change in debt. For the last decade, the latter factor has been adding to demand–and aggregate supply, asset prices, and our import bill have adjusted upwards to suit. But as the change in debt drops and ultimately turns negative, it will subtract from demand–and supply (read employment), asset prices and imports will follow it down.
If Australians decided to reduce their debt to income ratio by 10% each year–to get back to the 25% level that applied back in the 1960s (before this long-term speculative bubble took off)–it would take roughly 15 years to get there.
Chart One
Monthly change in Debt, Australia
Chart Two
Contribution to Demand from Change in Debt, Australia
Table One
Agggregate Debt Summary Australia
Disaggregated Debt Summary, Australia
Australia's 1964-2008 Debt Bubble
Australia's long term addiction to debtTrends in Disaggregated Debt, Australia
Monthly changes in disaggregated debt, Australia
October 6th, 2008 at 10:40 am
Steve, do we have other options for long-term debt to GDP ratios ? It seems to have been fairly stable at about 45% in the 1910’s. This represents about 3% of GDP in interest payments which seems acceptable.
Paul Keating described his pre-deregulation economics as “boring”, it seems were now living in “interesting times”. To understand Australian attitudes of the 50’s you really need to understand the Great Depression. My grandfather in 1932 had 5 children under 10, a mortgage and a job which he kept. For many others the consequences would have been unemployment, loss of house and reliance on charity. So for a while we get restrained debt and a rather strange economy where everyone is well paid, employment is high but everything costs a lot because of the tariffs.
October 6th, 2008 at 12:10 pm
Central banks create money either by printing it or by buying bonds in the treasury market. Shakira Liquidation
October 6th, 2008 at 3:51 pm
So where does Steve Keen put his money?
October 6th, 2008 at 5:30 pm
Steve,
Thanks so much for the monthly fright (the updated charts), and the debt deflation discussion. Looks like cash is going to be king (if we can keep it).
I have a request for you and others here. Last week the RBA became an agent for the US Fed Reserve when they enabled local access the the US TAF ‘facility’ via USD swaps to the tune of $10 billion. I understand another auction will take place this week for a further $20 billion… Aside from the radical impact on AUD/USD cross rates last week (and the nullifying effect on the access to cheap credit that was supposedly on offer), I am wondering how these transactions will be accounted for. I’m pretty sure they will show up in the ABS national accounts figures next year, but I’m wondering where I would see this in the RBA’s statistical releases ? Has the RBA in effect gone off balance sheet here ? I hope you can shed some light on this.
Cheers
October 6th, 2008 at 6:21 pm
Steve,
Thanks for the additional fright, I think I’ll head for the antidepressants.
More seriously (if thats possible), have you ever written any pieces on the migration rate’s influence on housing prices. We currently have the highest migration rate in years, so I expect that will keep housing prices up (the old supply/demand logic), especially if the migrants are well educated, have plenty of cash etc.
I suppose the same question could be applied to people in Australia who are doing well from the mining boom i.e. they have the cash and will keep on spending it etc.
Also, I noticed you mentioned peak oil. I take it you believe this will also influence the situation – maybe not for the better?
October 6th, 2008 at 10:21 pm
I’d like to know the answer to Keith’s question too please if anyone knows.
Re “Neoclassical microeconomics”… you mean Friedman’s eCONnomic theory:
Step 1: create a string of disasters whilst telling everyone not to worry because it’s all contained (ie strap dynamite to you back and light the fuse whilst telling the people around you not to worry because you are a bomb expert),
Step 2: Sit back and wait until the peak of the crisis (ie the dynamite is going to blow up and take everyone including you with it), and then extort money to fix the crisis (ie put out the lit fuse).
Step 3: While people are confused and frightened and throwing money willingly, siphon off the proceeds of your extortion to your cronies who helped you engineer the mess (ie throw the money you extorted from them out the window to your mates) and then slip quitely away (ie leave the dynamite in the room with your captives and flee the scene).
Step 4: The worst happens and people live in misery as a result of the fallout from the crisis (ie the dynamite explodes and kills everyone). The people change governments and whine a lot about how they never should have trusted the you when you said everything was OK. You get a cushy job consulting for your cronies paying off the new government and planning the next set of money-extorting crises.
You have to admire Friedman’s sociopathic genius.
October 7th, 2008 at 6:59 am
Steve
I’ve been following your arguments for a couple of years now and am glad to see you’re starting to get due recognition for sticking to your highly unpopular, but accurate summation of the folly of a debt fueled economy.
Like most people, I have no idea how much things will correct themselves this time around, but I do know that we need to learn our lessons from the pain, just as those that went through the Great Depression did. Isn’t it amazing how the work and savings patterns of those GD veterans were derided in recent times by the young turks who knew better? Of course “it is different now”, isn’t it???
It seems to me that one of the best things that we can learn from this debacle is that the our definition of “good” debt needs to change. The spivs and speculators have been telling us that “bad” debt financed depreciating “assets”, such as cars and plasmas. Their definition of “good” debt is that it is used to finance appreciating “assets”, such as real estate and shares. However, if those assets have only been increasing in “value” due to speculation of increasing prices and not productive capacity, then they should also fall into the “bad” debt category.
In other words, the only “good” debt is that which enables the productive capacity of the economy to increase and therefore enable us to repay the debt out of that increase. Our economic policies need to reflect this need to encourage increased production, not speculation.
Is it really that simple, or am I missing something here?
Cheers
October 7th, 2008 at 8:01 am
Dear Chewman,
I entirely agree with your analysis of good versus bad debt–it’s precisely what I’ve been telling my students, and journalists. What the conventional view calls “good” debt has been the force driving up asset prices, and leverage even more, leading ultimately to this crisis.
And where do I put my money Nick? At the moment, in cash and long term government bonds. I’ve never been one for riding stock or property market bubbles, which has cost me in terms of the gains I might have made; but I prefer to make my living from my work rather than asset price appreciation.
October 7th, 2008 at 8:14 am
Hi Steve,
I heard about you on Late Night Live. I have been trying to find an economist that preferred reality over clearly inadequate theoretical models for some time now. I think my search is over.
One question: CPI calculations do not take into account rises in house prices (only “owner equivalent rent”). Would the debt crisis have been mitigated or even avoided if the housing component of CPI was based on actual house prices instead? My reasoning is that that if you included house prices then during the recent property boom (or any property boom) measured CPI would be much higher. The Reserve Bank would then have had to raise interest rates which would have cooled off the property boom.
I could not and still do not understand why screaming asset inflation in property that was obviously driven by low interest rates did not cause the Reserve Bank to raise interest rates. Can you clarify the conventional economic misperception that created this blind spot?
October 7th, 2008 at 10:22 am
Steve,
Where you are wrong are your comments in regards to gold. How can you pro inflation and anti-gold at the sametime? (you said this at the Adelaide lecture this year). I read that during the 1930s, in the Great Depression, the purchasing power of gold bullion more than doubled for US investors as the DJIA index dropped 7/8ths of its value from top to bottom. For Japanese investors suffering from deflation in asset prices for nearly two decades the purchasing power of gold has risen more than 85% since 1989. If you look in regards to the purchasing power of stocks, in terms of real estate, food, the purchasing power of gold is rising.
October 7th, 2008 at 12:35 pm
Hi Steve,
Another great post…
The additional figures on Unemployment are very sobering ie 25% unemployment. I can only assume that all the same mitigating factors are in place in 2008 then 1929? and thus we should expect the same hit in labour hire especially with deflation exacerbating the lack of credit and therfore demand….
Could you clarify your thoughts more on employment in OZ? and in the coming years….is it possible that we could experience such a big unemployment rate here?
While I see the numbers make sense its hard to fathom millions of unemployed, many people living on the streets, shortage of food etc
Could we likely see a similar situation today to 1929 or is there something different about 2008?
Cheers
October 7th, 2008 at 12:51 pm
Dear Aussiebassguy,
I can be pro-inflation and anti-gold at the same time because I have supreme confidence in the ability of our economic managers to FAIL to cause inflation. So I actually expect deflation in the future, in which case the money price of gold may well fall (though it will surely fall less than other commodities).
However, I could be gazumped by global warming and peak oil, which could cause the inflationary surge that our economic managers will finally realise is needed, but not know how to consciously cause. There is also the slim possibility that truly over the top increases in fiat money could trigger a hyperinflation.
So given those two possibilities, I’m not anti-gold; it depresses me to say that I have actually started considering whether I might put some of my money into gold. But I would still prefer to remain in both bank deposits and my super fund’s so-called cash accounts.
October 7th, 2008 at 12:54 pm
Peter,
I can’t quantify exactly how bad it will be, but I’d certainly expect a peak unemployment level between that of 1990 (11%) and 1932 (20%) for Australia, and a sustained period of unemployment above the peak of 1990.
The attenuating factors this time round, which are important, are the size of the government sector, the implicit backing of deposits by the RBA, and the experience of the Great Depression where government spending was part of the turnaround.
On the other hand, the debt to GDP ratio is now more than twice what it was back then.
Do I think the former outweighs the latter? Unfortunately, no I don’t. But the balance isn’t linear either, and I don’t believe we’ll let the situation get as dire as it did in the 1930s before we reverse direction in economic policy–and consider debt moratoria and the like as we did belatedly in the 1930s.
October 7th, 2008 at 3:20 pm
Hi Steve, I’ve been increasingly interested in the close relationship between business and Government in policy making. I wonder if you could comment on the content of these links
http://www.treasury.gov.au/documents/851/PDF/FSAC_Charter.pdf
http://www.google.com/search?sourceid=navclient&ie=UTF-8&rlz=1T4SUNA_en___AU207&q=Financial+Sector+Advisory+Council
I thought it particularly ‘interesting’ that a specific objective of the council is
“To promote dialogue between the private sector and the Government in support of the development and growth of Australia’s financial sector”
October 7th, 2008 at 3:21 pm
Disciplines sometimes overlap. If one was to read historians of World War 2 you would frequently find the suggestion that the rearmament preceding the conflict was a major factor in ending the 1929 to 1934 Depression.
The figures you have graphed; Steve, suggest that the rearmament expenditure came later, 1936 to 1939, none the less the eventual recovery of the USA market to pre-crash level involved the transfer of much of Britain’s wealth to America and the destruction of vast amounts of European infrastructure, removing competition for America’s factories.
No empire today faces a “finest hour” in which it will be compelled to bankrupt itself for American weapons, indeed America itself is now the mendicant seeking allies to join and fund its wars.
The rearmament funding provided a long period of “pump priming” for the USA in the 1930s and 40s. To what extend do you consider that this help the USA to escape the depression? Is there any comparable stimulus foreseeable and if not, can the USA avoid near total implosion?
October 7th, 2008 at 3:42 pm
Dear Mr Keen,
Thanks very much for your explanations.
If at all possible, I would like a clarification on Fishers sequence of events; specifically from stage 2 to stage 3.
I see that all the loans being paid off contracts the amount of loaned money, and slows therefore the velocity of circulation. But I can’t understand why this leads to prices falling.
Is this a reflection of supply and demand – no one has money they are willing to spend; therefore prices fall as sellers get desperate for buyers?
If this is the process then what happens once the selling price reaches the cost price for the seller? Doesn’t he just go bankrupt?
Maybe I answered my own question – or maybe I completely missed the boat.
Any comment gratefully accepted.
Regards
Ralph
October 7th, 2008 at 4:22 pm
Dear Steve, great article – thank you. But I must question this part:
“Then along came the Subprime Crisis, and we received a rude reminder of why Central Banks were created in the first place: to ensure that the world would never again experience a Great Depression.”
In the USA the Federal Reserve was created in 1913, well before the great depression and – by their own admission – their actions were a great deal the cause OF the depression (and contributed to the extended recovery time). Even if you don’t accept their admission most would admit that they have a disastrous track record.
Our own RBA has become somewhat discredited over the past year when they repeatedly insisted that inflation – and inflation ALONE – was their regulator for interest rates. They clung to this yarn right up until until the worlds financial system started to tank….
October 7th, 2008 at 4:31 pm
Steve
Am I right in thinking (very simplistically)that your take on the migration issue is that all that really matters is the ratio of debt to GDP, and that the extent of migration simply feeds into the GDP part of the ratio.
And, thus, that your conclusion is that this ratio is still far too high even once the effect of migration is taking into account.
Also, what do you make of the fact that Sydney, in particular, appears to be land-constrained in way that most places in the US / UK are not?
Thanks
DJB
October 7th, 2008 at 7:44 pm
Steve
Interesting a few mainstream economic strategists have come into line with your view recently.
This from Peter Osborne, Merrill Lynch: “We consider that the structural credit super cycle is now mature. The household sector has hit significant level barriers (imbalances) in terms of debt levels, debt servicing burdens and asset prices. These were built through the long credit super-cycle, but have extended further during the strong EM growth phase and positive terms of trade income shock over recent years.
Australian households need to de-lever
Australia faces external funding constraints on growth through the CAD. This will become manifest through a de-leveraging of the household sector balance sheet over the medium-term. At this point, we believe Australia has sufficient fundamental defences to work through this adjustment without a hard landing …
However … the risk of a more severe downturn in world growth next year is rising rapidly. This would reverse the positive terms of trade income shock to Australia and force the economy into a more aggressive de-leveraging phase. The falling terms of trade would flow directly to lower corporate and household incomes (rising unemployment), weaker growth and falling asset prices (particularly house prices). Inextricably linked to this de-leveraging process is the current account deficit. The world would likely force a lift in Australia’s national savings rate, and a reduction in growth, earnings and the CAD.”
This from Morgan Stanley credit strategist Neil McLeish(Oct 6): “We continue to believe that the 2007 credit cycle peak represented not only the peak of a ‘vanilla’ cycle that started
in 2003, but also the peak of a near-30-year ‘debt supercycle’ that started as long ago as the early 1980s. If we are correct, the current credit downturn represents the start of only the third large-scale debt supercycle unwind of the last 100 years.
No wonder events are overwhelming – we are witnessing deleveraging and asset price deflation on a scale never before witnessed by currently active investors. The unwind of
the supercycle will end with, among other things, lower private sector leverage across a number of developed economies and a smaller and less complex financial sector.”
Note though that he thinks markets are overestimating the probability of debt deflation.
October 7th, 2008 at 9:13 pm
As someone else has mentioned, the current huge immigration rate, and tight housing stock will surely prevent significant falls in housing prices in Oz inner cities. Yes, they’ve already dropped 10%, but I can’t see it going beyond 15%. Half of India is pouring in, and they’ll all want homes.
October 7th, 2008 at 9:13 pm
Hi Steve,
I am please to see a maverick amoung the economic conservatives. My question relates to house prices: How low do you think house prices will go in Wollongong in the up-coming 12 months? It appears real estate agents are relying on the RBA rate cuts to fuel a property price turn around, what are your thoughts in laymans terms, as I know little about economics? It appears also that the technical arguements presented on this website maybe all correct, but what about the psychology of the average punter who believes the spin on property and share prices rising upwards once again? Are these punters really rational? If they were, there would be no price bubbles in the first place. Furthermore, as someone who would like to buy a first property, I have to compete with irrational buyers who accept the fodder from less logical and academically sound sources ie real estate agents. So, as a final comment: ‘you can have all the technical arguements in the world, but if the average punter’s consumer psychology is stuffed aren’t the technical and economic debt arguements incomplete and biased towards theory at the cost of studying irrational economic behaviours within the human organism? Afterall, no one was holding a gun to the now debt impoverished souls. I like to hear your thoughts on psycho-economics in regards to house pricing.
cheers,
Stewart
October 7th, 2008 at 9:55 pm
Hi Steve,
Thanks for making your analysis and thoughts publically available on your blog. Excellent stuff.
Can I ask about the numbers in “Disaggregated Debt Summary: Australia”?
Personal debt is shown as growing by 2.5% in nominal terms over the last year. Personal debt divided by GDP is shown as falling by 5.76%. By my figuring this means that GDP grew by 8.76% in that period, which sounds too high.
Have I misunderstood?
Thanks very much.
October 7th, 2008 at 10:25 pm
Ralph said; “I would like a clarification on Fishers sequence of events; specifically from stage 2 to stage 3. … what happens once the selling price reaches the cost price for the seller? Doesn’t he just go bankrupt?”
Yes. And a large number of sellers going bankrupt can push the price below cost. Why would you buy a house at “cost” if there’s a bankruptcy sale down the road going for 40% less. Plus if you can wait a week it might be even cheaper.
SAVEME2 said; “How low do you think house prices will go …”
House prices should go down to the point that rent, minus the estimated risk of the house being empty, easily covers interest repayments on an investment property. A rational bank manager should not value a house higher than this amount or he risks you defaulting on the loan. Ideally it shouldn’t matter if buyers are irrational if they are unable to secure finance (and if they had the means to buy the house outright they are more likely to be rational about its value).
If you include the effects of a deflationary depression, as incomes shrink, the amount of rent people can pay will shrink and house prices will fall even further.
October 7th, 2008 at 11:00 pm
The need for immigrants is driven by demand. Demand is driven by increases in debt, which the migrants add to, but not in any massive way. The population is not actually growing that fast because we don’t produce a lot of our own children.
So immigration isn’t really a factor. Anyway think about population increasing at 1% per year and debt at 20+%, there is a bit of a disparity.
So when demand drops off, immigration drops off as well and suddenly it wont look like we need anything much in the way of new houses. Many of our more recent migrants will return home, probably leaving the banks with a few more problems.
SAVEME2 the solution is simple: wait. Prices will drop and also you will have a much better idea of employment status.
October 7th, 2008 at 11:00 pm
There is one factor here that tends to be overlooked and that is the demographic changes that are occurring in our society.
The baby boomers–after long years of accumulation–are going to be selling their depreciating assets to finance their retirement. I think this is going to put long term negative pressure on asset values. Furthermore, their large cohort size and hence political clout will probably ensure that taxes will remain relatively high and expenditures will be geared towards servicing their health and care needs. I must admit I’m seeing a very long term period (15-20years) of in real terms asset deflation. I’m seeing capital for new projects being very constrained for a long, long, time.
In my very limited reading of economics, I must agree, that economists don’t seem to differentiate between the qualitative differences on how profits are made. There does seem to be a difference between productive vs speculative profit just like there seems to be a difference between good and bad debt. Perhaps trashing our manufacturing base was not such a good idea.
Oh and by the way, London has a rental shortage and falling property prices. Go figure.
October 8th, 2008 at 1:12 am
Ken,
Australia’s population is growing fast. It goes up approximately 1 million every 3-4 years. Labour recently increased our migrant intake and our population birth rate also recently increased.
Our birth rate is very high by first world standards. Just from births alone, Australias population will increase for ~30 years. I know this sounds hard to believe considering what the media often says, but the reality is our birth rate is higher than our death rate.
To what degree this will influence housing prices I don’t know, but it does not surprise me that the housing industry is pro higher migration.
October 8th, 2008 at 8:46 am
Paul, Ken,
Hopefully our migration policies will be reviewed sometime during the coming recession. I have absolutely nothing against migration or migrants, but the carrying capacity of this country is pretty strained, thanks to our abysmal record on water and soil conservation. I recall studies indicating that Australia’s population limit with respect to soil sustainability is around 35 – 40 million. While there is currently a lot of political concern expressed about water (and that’s a good thing if realistic and practical actions follow), the soil salinity and conservation issues have completely faded from the radar. We are exporting less food to the rest of the world (yes, there have been a few bad seasons thrown in, but the trend is down) due the combined effects of increasing population, and reductions in available, well watered land (some of which has been ironically buried under real estate subdivisions). Zero population growth is also off the agenda in most countries these days, as no economist that I am aware of can put forward any kind of management framework for flat economic growth, they are all mesmerised by inflation in some shape or form.
October 8th, 2008 at 9:28 am
Hi Steve,
I have a couple of questions about the the direction the economy is headed but here and in the US. My understanding is that Bernake and Stevens are from the same school of economics, however most predictions I have seen for the US are that it is heading towards an inflationary recession/hyper-inflationary scenario while here in Oz you are predicting a deflationary recession.
If both of these guys are from the same school and both our countries have similar levels of debt then why won’t we end up in the same situation?
And assuming that we are headed for one or the other which would be the better of two evils for the Australian public?
October 8th, 2008 at 9:28 am
Paul, the population growth rate is still only 1.2% When you look at the figures there is only 1.78 children born/woman and a low death rate of 6.68 deaths/1000. The whole pattern seems to be the effect of immigration boosting the 20 and 30 year old population. Stop immigration and there will be a shift to an older population and consequently lower birth rate.
October 8th, 2008 at 10:22 am
Hi Steve,
could you clarify how Fisher’s description of debt-deflation in a context of low inflation differs from Keynes’ liquidity trap?
October 8th, 2008 at 1:56 pm
Ken,
Immigration does not help the aging population problem as most migrants are mature age. This was confirmed a few years ago as the then government did a study on this and came to this conclusion. It then introduced the baby bonus as a direct response to the ageing population “problem”.
Researchers who study population generally agree that a birth rate of 1.6 or higher is adequate. This was heavily discussed in the population conference in Canberra in 2004. Australia’s birth rate has always been well above that.
Keith, I agree with you. Australia is primarily a desert and the environmental consequences and pressures of population growth are well known. Our fisheries are also small as our waters are primarily nutrient poor. Also, food production in Australia is by world standards low (food grown per hectare) and it is expected do decrease due to environmental degredation.
The other reality is that at some point all the world will hafto face up having an ageing population. The sooner it acknowledges this the sooner the economy can adjust accordingly.
Steve, any thoughts?
October 8th, 2008 at 2:22 pm
The one element missing ,at least in Australia,is deflation.Clearly the Reserve has switched from targetting a rate between 2%-3% & has decided to prime the economy with rate reductions instead.So if inflation re-ignites(and a dramatically lower dollar will push prices up)where do we stand with recession/depression? I’ll await the next inflation figures with interest.
October 8th, 2008 at 3:21 pm
Steve, Just wondering whether – now that the writing is on the wall – the incidence of media requests on your time is following a similar trajectory to Australia’s debt bubble 1964-2008? Seriously, you’re everywhere at the moment – which is great – but can you give us an idea of how interested the media was in your work a few years back? I’d really be interested in the insight. This is something I mentioned in a recent video – the great shame that the media, including those that are supposed to provide robust analysis, only actually admits to bubbles after they’ve burst. If only they were more upfront – the bubbles may be smaller and cause less disruption to people and societies!
October 8th, 2008 at 3:48 pm
IOU’s can only be redeemed for Goods Services or Assets.
Since Australia issued roughly 1.5 times more IOU’s/GDP than the USA during the 1990 – 2007 period the obvious outcome for the AUD over the next 5 years is a declining exchange ratio and it will be roughly proportional to the IOU issuance ratio.
AUD/USD @ 50 cents
October 8th, 2008 at 6:22 pm
I put all my money in stock. Now is the time to buy quality stock at discount that provide you a margin of safety.
Better to buy in Bear market when fear and anger cause stock market to behave irrationally and make it an inefficient market.
October 8th, 2008 at 8:33 pm
Brett,
You make a very pertinent point about the media. I typically watch the ABC news, and in general the only people who are interviewed are economists employed by the big banks, with occasional appearances by Access economics, and Steve Koukoulis (I think I got the name right). Koukoulis got dropped off the ABC appearance list late last year, for whatever reason. I would note however that his last appearances saw him starting to sound like another ‘SK’ whom we all admire.
Steve,
I just saw you on the 730 report. Excellent. My wife (a professional lady who works very hard in her own field that has nothing much to do with economics or finance) was able to assimilate the import of your talking points very easily. She said my ranting about the situation over the last couple of years probably sensitised her to your message, but I think your interview was extremely useful.
Even your blog got a plug from Kerry. Are you tracking your page hits ?
Hopefully your message of ‘pay down debt’ will gain greater exposure with the average person/family, and maybe a few quiet invites from Canberra might come your way in the future.
Cheers,
Keith
October 8th, 2008 at 9:40 pm
Steven
your research on this subject is largely focused on private debt. Currently, there are significant government incentives, specifically in the form of negative gearing tax concessions, that are driving at least part of the behaviour around going into debt for investment. For example, people who own their home or at least have a large equity in their home have mortgaged the home for a second property. I think govt. (tax) policy needs to be changed in this area so that there is less incentive for speculative borrowing and more incentive for savings. We keep getting told that we (Australians) are not saving enough. Currently we get taxed at our marginal rates on interest earned on savings. This needs to change to encourage savings and to enable people to earn reasonable returns on deposits. By doing this people would be less likely to take on the more risky speculative investments that involve carrying significant debt. I would be interested in your comments on this subject.
cheers
Doug
October 8th, 2008 at 10:25 pm
Hey Steve,
I am concerned about the likelihood of a massive house price drop given our high house prices and lack of affordability.
I have a $240,000 mortgage on an apartment (where I live) currently valued at approx $450,000 in inner east Melbourne. I am currently studying postgraduate studies fulltime while being well ahead on my payments and working 1 day a week.
Just wondering how you far you forsee prices dropping… and when do you forsee the decline to happen? How do you forsee such a crisis unfolding?
I am contemplating either 1) selling the apartment and getting the cash out or 2) going part time with study and getting a full time job.
If I did sell the property… is a bank a safe place to keep the equity?
Thanks,
Dave
October 8th, 2008 at 11:24 pm
There is a wider lesson to be learned here with the current financial meltdown. Our economy and that of many other nations use tax deductions to stimulate growth, some like negative gearing in Australia have a rather dubious value but are guarded as a right for investors.
A revue of taxation and monetry policy is needed to rejig our economy and head it in a more productive direction, one that is steered away from the creation of wealth by capital being shuffled instead of its application to productivite industry.
October 8th, 2008 at 11:29 pm
Hi Steve,
Its been a long time since I last added a comment to your blog, I must tell you that is a weekly read for me and really appreciate all the hard work that you have done. I have just seen your appearance on the 7.30 report and wanted to say thankyou for telling Australia how it really is.
I too have focused my career for the last 7 years explaining to people why they need to reduce debt and focus on controling their cashflow. It is something I am truely passionate about and have put every ounce of energy into, however it has been recieved with as much enthusiasm as peddling a hangover cure at a Bucks Party at 2am in the morning.
“Standing against the tide” is a tremendously difficult thing to do and I particularly admire you for that.
Now the tide has changed…
Its just sad knowing the suffering that many will have to endure as they get washed out to sea, if only they could have heared the message over the noise of the “over consumption” party.
Perhaps this global downturn will see a beneficial correction for the environment and for society in general… droping consumerism for true family values.
Only time will tell.
Keep up the good work Steve,
Kind regards, Allan
October 8th, 2008 at 11:37 pm
Steve,
At this point the Australian public is overdue for unlimited retail bank deposit guarantees(effectively creating defacto bonds).
With the growing uncertainty around the prospect of continued funding from the international credit markets for our banks; its either that or bypass the banking system and purchase bonds.Your thoughts?
October 9th, 2008 at 12:49 am
Dear Steve,
Get it in perspective…
Its not the houses, the cars, nor the credit cards…
If the imagined value of the worlds stockmarket was the size of the mooon…
And the imaginary imagined value of the futures market was the same as the earth…
Then the imagined imaginary value of the derivitaves is the size of our nearest star the SUN…
So when the dealer says youve lost and you and you sir and losers abound until yes we have a winner (someone has to win)
what are they going to pay them with ?
Air ?
Sand ?
The gamblers had sand in bags marked ‘gold’ and the casino said take a seat… and they bet higher going beyond the entire value of the real assets of the whole entire world…
The annual bets alone exceed 1 Quadrillion dollars
thats a Million Trillions
A Trillion is a 1 with 12 o’s
1,000,000,000,000
1 million x 1 million x 1 million
or 1 million x 1,000,000,000,000
or 1,000,000,000,000,000,000
Quadrillion imaginary dollars = A MILLION TRILLIONS. A quadrillion is a thousand trillion. A million trillion is a quintillion. Well in US units anyway, which are universally used.
they dont even have $1 trillion in reserve…
they definitely dont have $10 trillion
they cannot have $100 trillion
its impossible to have $1000 trillion
Can you see the fraud ?
What is the value of the derivatives traded annually in US ?
What is the value of the REAL world ?
What is the GDP of the REAL world ?
Deriratives is gambling on the movement of anything up or down, like flipping a coin WANNA BET THE FARM BOYS ?
Last year, DTC processed over 164 million book-entry deliveries valued at more than $77 trillion. How many zeros is in a trillion ?
A million million is 1 followed by 12 ‘0’s … 1,000,000 x 1,000,000
But they traded 77 x 1,000,000 x 1,000,000 that’s not even in the bank ?
A conga line of lost bets at the casino goes home to pappy and says SORRY pappy You gotta pay these OL boy or else were broke ?
Pappy should say boy did you have that money in your bank when you bet it ?
Did the other boys put their money up on the table ?
Did they ever hold the money they said they were holdin in the bank ?
FRAUD IS FRAUD.. FOR YOU TO LOSE SOMETHING… YOU GOTTA HOLD IT FIRST
FOR SOMEONE TO WIN THEY GOTTA HOLD WHAT THEY WERE BETTING WITH ‘PRIOR TO’ THE GAMBLE..
THERE IS NOT 77 TRILLION IN THE ENTIRE BANKING SYSTEM LOOK AT THEIR RESERVES…
EVEN THEIR ENTIRE CAPITAL IS NOT 77 TRILLION…
SO WHOS BEEN BETTING WITHOUT THE BANK ?
A NAKED BET WITHOUT THE MONEY TO BET WITH IS AT THE RISK OF THE WINNER ( CAVEAT EMPTOR) NOT THE PEOPLE, AND IF FRAUDS EVIDENT IT BECOMES A CRIMINAL MATTER..
Remember Rene Rivkin went to jail for trading $50,000 Qantas shares which made a profit of under $500.00… compare that lil half a monkey $500 to the $Trillions being looted
October 9th, 2008 at 1:14 am
Now we get a carbon tax $$$
NOW we get a huge loan debt financing debt sinkhole
NOW were raiding the Future Fund (that was quick)
NOW were looking for more tolls and pty ltd monopolies to start charging you for your problems…
Lets face it the Stock Market is Insolvent, it consists of debt for CAPITAL is DEBT
THE SHARES ARE SHARES OF DEBT
IF YOU ADD UP THE PHYSICAL REAL ASSETS LESS ALL THE LOANS AND CAPITAL DEBT LIABILITY ETC
ITS NEGATIVE EQUITY -MINUS LESS THAN $0.00
trading an insolvent company is a crime
EVEN THE MINES DO NOT OWN THE METALS in the soil they belong to the common-wealth people you me we 21 million…were allowing foreign pty ltd to rape our best and fairest reserves for very little royalties shared in return…
Instead of efficiency and creating our OWN money from our Minerals and Metals and Oil and Trees storing more carbon co2 than we use…
Kaptain Krudd is gonna go in debt to China or Arabia where the interest must be paid..
unless hes gunna keep borrowing funny US dollars and broken pounds…backed by paper by more paper and more empty nothing fiat currency that demands real product as its interest ?
whitlam got caught in the Khemlani arab banking switch away from london … it wasnt the debt but the very source of the debt, or the switch away from 200 years of begging for pounds and paying them back with gold, that caused the dismissal.. a mafia racket doesnt like its payroll being taken…
Australia should print its own currency backed by the trillions of dollars of common-wealth assets found in ‘our golden soil’… instead of borrowing from London and New Yorks failed banks.
We need the Australian Metal and Mineral Common Wealth Bank to finance its own economy at cost (the small margin of administration) then we can finance the world in exchange for its products and services in return … thank you.
We are selling our minerals metals and oil for paper. madness or planned slavery ?
STOP leave it in the ground and sell the dollars backed by these incredible assets that really exist, leave it in the ground theres no safer bank in Australia than its land bank.
Abandon the LME london metals exchange make it the COAME Common-wealth of Australia Metals Exchange make them use the A$ for trading…
We can then get a national dividend pay off our debts finance internally at only the marginal cost and fixed profit to OUR Bank and finance.. credible real performing assets around the world and import guest workers…
Lay back and relax then….
Aahhh champagne and caviar…
October 9th, 2008 at 1:32 am
Steve, saw you on the 7:30 Report, welcome the straight talk.
Gold business at the retail level is at record levels – I just hope they aren’t gearing into it!
October 9th, 2008 at 1:35 am
See if you can understand just how rich we are
Population 0.3% of the world
Land over 5% of the worlds earth … literally billions of acres…full of wealth… common-wealth metals minerals oil and gas…
If you divided our wealth evenly we are richer than the Arabs who only have OIL and Sand
Our 3rd biggest export is OIL we export it to the 3rd world Vietnam & Indonesia for nothing and their population pays 40c per litre…for OUR oil…we pay 400% what they pay… madness or slavery ?
Our biggest export is COAL
followed by IRON ORE
then OIL
the only oil we import is our refined OIL plus a small amount of heavy oil for greases lubricants etc…
There is Gold all the way from Tasmania to Cape York and if we mined the stuff up wed be so rich we could never spend it or get to the bottom there would be thousands of years supply… most of has been surveyed and recorded (they can prove it)
And then theres hundreds of years of coal,
Thousands of years Iron Ore, unimaginable quanties of Gas etc etc etc
Meanwhile a pensioner starves…
October 9th, 2008 at 2:43 am
Hello Steve
It was good to see you on the 7:30 report, perhaps the press at least is starting to understand that you have a very important point to make.
On the program and in this blog you mention unmemployment now and in the 1930s. From my reasearch I think the real unemployment figures for the current period which started in about 1976 are much closer to those in the 1930s than appears from just considering the ABS numbers.
From me research about three years ago I noticed that in the mid 1960’s the rate halved from about 2% to 1%. When I looked for a reason for this I discovered that the ABS took over the determination of unemployment levels at that time. They introduced the most restrictive definitions of “unemployed” and “participating” that I can find for any country. One hours work, paid or unpaid, in a two week period is now all that is required for a person to be considered fully employed.
Prior to this change I discovered claims that statistics were produced by the trade union movement and unemplyment was calculated on a pro-rata hour basis but I have not been able to verify this to my satisfaction. If this is correct the historic figures would include the effect of widespread part time work and job sharing which took place during the great depression. In any case I think that the trade unions would be more likely to overstate than understate unemployment levels.
Now if this is correct I estimate that the current unemployment rate is much closer to the 1930s level than anyone is currently admitting and this was before the current debacle!
I also note that there is no international standard definition of, or a specified method of, determining unemployment levels or for that matter determining any other vital data set! What on earth is the purpose of the International Monetary Fund? Surely it should standardise the collection of such data? How can countries be compared? How can decisions be made? The whole neo-classical theory it seems, is a house of cards built on a foundation of custard!
The Inernational Telecommunications Union adopts standards which are used around the world the Internet would not work without these standards!
Many thanks for your efforts, you are one of the only voices of reason towering above this gaggle of idiots!
October 9th, 2008 at 10:00 am
Re idiots…came a statement from the Economics conference at the GC last weekend. Reportedly Warren Hogan stated that the reason Aus can run continuously large CAD’s was because we have such strong banks (as if the CAD’s at least don’t matter and more like they are a good thing!). Now, while there may be a bit of surface truth to this…I mean we would be in a load of trouble if our banks were failing just now, I keep wondering if a single thought later ran through his head of the serious stupidity of the statement from a policy and national welfare viewpoint.
I just feel that carts horses and fools got mixed together at the GC last weekend.
On the other hand, I guess banks make larger profits moving money around under a large CAD regime!!!
October 9th, 2008 at 10:02 am
Steve
How do i get in touch with you? Could you send an email to the address i have given. many thanks
October 9th, 2008 at 10:20 am
Hi Steve (again)
Nice interview with Kerry. I just wondered how you see our current account deficit playing out over the next few years – especially in relation to your views on best/worst case scenarios, and RBA cash rate of 2% by end of 2009 and 0% end of 2010? I had been thinking that there is a risk of a current account crisis – driven by risk aversion, which does seem to be playing out given the precipitous drop in the AUD – and this could lead to a very significant raising of interest rates… Would appreciate your views (but realise that you are getting busier by the day!)
October 9th, 2008 at 11:33 am
Steve,
Greatly appreciated your insights on ABC last night. Realism in the face of those who expect a return to their perception of “normality.”
Can you foresee any recovery while international trade remains denominated in US$?
When the UK was in strife in the 1970’s it could be propted up by the IMF with loans of US$ and SDRs. Is this possible in the present case of the USA where the bad debts are defused through the private citizens but the currency is the medium of international trade?