A quick quiz: when did Australia’s biggest private debt bubble burst?
A young Gough Whitlam
If you consider the rate of increase of debt, the correct answer is “in mid-1973″. The bubble started to expand a year before Whitlam came to power, and its collapse during Whitlam’s term was the real–but at the time, unappreciated–cause of the economic crisis that undid his government.
However, if you consider the rate of growth of debt relative to GDP, the correct answer is “in early 2008″. This bubble started well before the Rudd Government came to power–its origins can be traced back to the depths of the 1990s recession, when private debt was falling at
about 1.5 percent per annum–and its bursting shortly after Rudd assumed office is the cause of the domestic financial crisis we are only just entering.
Today, there is general awareness that the economic crisis is not Rudd’s fault–since a global economic crisis was well underway by the time of the 2007 election campaign–in marked contrast to the way that Whitlam’s government has been unjustly demonised in Australia’s popular economic history. But how Rudd’s government responds to this far greater crisis will determine whether it goes down in history as “Whitlamesque”.
Growth Rates of Australian Private Debt
In December 1972, the ALP (Australian Labor Party) defeated the Liberal Party, which had held office for 23 years. Led by the charismatic Gough Whitlam, it won even though its incumbent rivals could take the credit for a booming economy, because voters took good economic performance for granted. The ALP promised to reverse many of the unpopular social and foreign affairs policies of the incumbent conservative political party–most notably its support for the American war in Vietnam–and this secured them the majority of votes.
Once in office, it quickly set about reversing those policies, starting with a withdrawal from the war in Vietnam on literally its first day in office. It truly began its term in office with a bang.
It departed the same way, a mere three years later, sacked by the Governor-General, and voted out of office at the subsequent elections. The cause of its defeat was an economic crisis that saw unemployment climb from 2.3% at the time of its election, to 4.8% at the time of its dismissal. Simultaneously, inflation exploded from a mere 5% when it was elected, to a peak of 18% in the months leading up to its collapse. When the electoral door was emphatically slammed in its face by the Australian electorate, inflation was still running at 14% p.a.
Stagflation: Rising Inflation and Unemployment
Government finances were also in tatters. The Government deficit had been running at 1% of GDP when it took office, blew out to 4.3% of GDP by the time of the government’s demise.
Deficits were the rule during the boom beforehand, but blew out as the recession hit
Though the ALP continues to treat Gough Whitlam with great reverence, the reputation his government gained for economic incompetence is one that the ALP has spent decades distancing itself from. The ALP remains progressive (or in the American parlance, “liberal”) on social issues, but ever since the election of the Hawke Labor Government in 1983, it has proudly declared itself to be economically conservative: in favour of small government, low inflation, government surpluses, and the privatisation of inefficient state enterprises (Hawke’s ALP had won office on the back of an election manifesto called The Accord, which had many not -so- conservative elements, but most of these were rapidly abandoned once the party was in office).
Rudd–Whitlam Mark II?
A contemporary Kevin Rudd
In November 2007, the ALP defeated the Liberal Party. which had held office for 11 years. Led by the outwardly affable Kevin Rudd, it won even though its incumbent rivals could take the credit for a booming economy, because voters took good economic performance for granted (well, that was how the Liberal Party reacted to the news of its impending demise). The ALP promised to reverse many of the unpopular social and foreign affairs policies of the Liberal Government–most notably harsh industrial relations laws and its uncritical support for the American war in Iraq.
Once in office, the ALP set up lots of enquiries to consider what to do about those policies, and reversed a few of them–most notably the refusal of John Howard’s Liberal Party to apologise to Aboriginal Australians for their treatment under the racist laws that prevailed before the repeal of the White Australia policy by the Whitlam Government in 1973.
The ALP kept its promise to maintain the economic conservatism of its political rivals–in fact, it attempted to be even more conservative than they were by running an even bigger Budget surplus. The intention was to do help reduce inflation (which was 3 percent at the time of the election, and rising rapidly) and thus discourage Australia’s independent central bank, the Reserve Bank of Australia (RBA) from increasing interest rates any further. The first Rudd Budget even planned for an increase a slight rise in unemployment to the still acceptable level of 4.75 percent.
Before the crisis, rising inflation and falling unemployment
Then the Global Financial Crisis hit. The Rudd Government rapidly switched from so-called conservative positions on economic policy–”inflation is public enemy number one” and “budget surpluses are good policy”–to “forget inflation and man the fiscal pumps”.
The same policy switch is happening all over the world in response to this unprecedented crisis, but the abrupt switch in policy by Rudd has led some observers–particularly the Liberal Party opposition leader Malcolm Turnbull–to raise the spectre of Whitlam.
Turnbull’s political spin has rightly been mocked by the media–Paul William’s thoughtful piece in the Australian is a good instance of this (Whitlam insult used as ultimate political insult)–but there is a way in which it is quite apt to compare Rudd to Whitlam on economics.
Whitlam’s Government was undone by a debt-induced economic collapse that it didn’t see coming, and Rudd’s Government may well go the same way.
Regular readers of Debtwatch will be familiar with the fact that private debt (the sum of business and household debt) has grown faster 4.2% than nominal GDP for the 44 years from mid-1964 to mid-2008. This debt bubble was the cause of our apparent but illusory prosperity in the past 3 decades, and its bursting (along with that of many similar bubbles in our trading partners) is the real cause of the current economic downturn.
There are however two obvious super-bubbles on that overall bubble. In the first, which began in 1972 a year before the election of the Whitlam government, debt exploded from a mere 33.67 percent of GDP to 44.75% in just two years. It was the bursting of this debt bubble, and not any actual economic mismanagement by Whitlam’s ALP, that caused the economic crisis that ended his government.
The debt superbubble of 1972-76
Undone by debt
The debt growth rate accelerated dramatically during this superbubble. Debt grew 4.2% faster than GDP for the whole 44 year period, but 15.5% faster over this two year extravaganza. As a result, even though the debt was much smaller relative to GDP than it is now, the increase in debt made a huge contribution to aggregate demand: in 1974, the increase in debt accounted for more than 10 percent of aggregate spending in the Australian economy, up from just 4 percent a year earlier.
Debt's contribution to demand exploded and then collapsed
The growth in debt financed spending fuelled a stock market boom, and helped to drive unemployment down from 2.5% in mid 1972 to 1.75% by mid 1973.
But this superbubble was clearly unsustainable, and it had to burst: if it had instead kept going, private debt would now be equivalent to over 100 times our GDP, versus the still unsustainable current ratio of 1.75 times GDP (when corporate bonds are factored in).
When the 1972 superbubble burst just two years after it started, the change in debt went from adding to demand to subtracting from it, and both the economy and the stock market tanked.
The Stock Market Boom & Bust of 72-75
Unemployment rose from 1.75% to 5%, while the Stock Exchange lost 59% from its peak in January 1973 to its low in September 1974. At the time, this was the biggest stock market crash since the Great Depression, but this seems to have been forgotten, while the Whitlam Government is remembered–and blamed–for the consequences of financial events that began before it took office, and which overwhelmed it without it even being aware of them.
Thus while bad economic management by Whitlam and his Treasurer Jim Cairns, OPEC’s oil price hike, and excessive wage demands by trade unions took the rap, the real killer of the Whitlam Government was private debt. The Whitlam Government was unlucky enough to come to power when the lessons of the Great Depression had been thoroughly forgotten, when a rising level of debt had started to dominate economic activity, and when what is probably the greatest ever debt bubble in human history had its first stumble.
The same pattern of rising debt dependence continued after Whitlam’s demise–and became more marked as debt grew relative to GDP–so that even relatively small changes in debt compared to the 1972-74 superbubble could have a large impact on demand. The recession that ended the Fraser Liberal Goverment’s term in 1983 was also driven in part by a decline in debt’s contribution to demand.
Debt & Unemployment 80-95
The boom under Hawke and Keating between 1984 and 1989 was emphatically driven by rising debt, while Paul Keating’s “recession we had to have” in 1990 was caused by the bursting of a debt bubble.
Now, even more so than for the Whitlam Government, the Rudd Government’s modest economic plans have been overtaken by financial events that were set in train long before it came to office. There is no prospect that Rudd will be blamed for causing the crisis, since it was already obvious that this was a global crisis that had already started before Rudd took office. But there is a very strong prospect that economic conditions will worsen dramatically on his watch, and the conventional “Keynesian” policies he follows will fail to control the decline–just as the conventional Keynesian policies that Jim Cairns adopted in the 1970s failed to arrest the economic decline back then.
Debt & Unemployment during the 95-08 Boom
Correlation is not causation of course. But the correlation between changes in debt and unemployment is strikingly visible in the long run plot, and the causal mechanism behind it is simple. Aggregate spending is the sum of nominal GDP plus change in debt, and as debt grows relative to GDP, the dramatic changes in debt start to outweigh the more gradual changes in GDP in terms of the impact on economic activity. So when debt rises, unemployment falls–and vice versa.
Debt Dependency: Unemployment Falls when Debt Rises
These next two tables put that visual correlation into statistical form. If we look at the whole period from the mid-1960s till now, there is no particular pattern between debt’s contribution to demand and unemployment–the simple reason for this being that back in the early 60s’ debt’s contribution to demand was pretty immaterial: income (GDP) was the source for the vast majority of demand, and the ups and downs of debt were pretty irrelevant. But as debt grew relative to GDP, its ups and downs became more and more significant an influence on overall economic activity–and hence on the unemployment rate.
Growing Correlation between Change in Debt and Unemployment
As T1 above shows, by the time we hit the mid-1980s–when the debt to GDP ratio was more than twice the sustainable level it had been from 1945-1965–changes in the contribution that debt made to demand accounted for 95% of the variation in unemployment.
The same pattern can be seen in the rolling 5 year correlations shown in Table 2: as time goes on, changes in debt come to swamp changes in output as determinants of economic activity and hence unemployment (the correlations would be higher still if the series were lagged to take account of the fact that unemployment changes direction well after debt does).
Ten Year Correlations
One apparent paradox is that the changes in debt itself have gotten smaller over time. The 1970s bubble that killed the Whitlam government saw debt grow by 35 percent in one year; but the maximum rate of growth of debt during our current bubble was only 17 percent.
Smaller Debt Changes But Bigger Impacts on Spending
However, the reason for this is that debt is so much greater now than then that even tiny movements in debt now shake the economic house. The 1970s 35 percent debt bubble translated to only an 11 percent rate of increase in the debt to GDP ratio, whereas the 2000’s 17 percent bubble drove up the debt to GDP ratio at a maximum rate of 24 percent–because private debt is now 1.65 times GDP.
Debt is truly the elephant in the economic living room, and one that our conventional neoclassical economic managers have ignored as it has grown from “Hatari-scale” to that of a raging bull. That bull elephant has now changed direction, and it is only a matter of time before this results in rapidly rising unemployment in Australia.
No more leveraged rescues
So in one sense, Rudd really is the new Whitlam. His government’s economic dilemma was laid down before it came to office, by a debt bubble whose collapse he now has to manage.
This was not even apparent to the Whitlam Government at the time, and it copped the flak for the economic collapse that was in reality beyond its control (and replicated, at slightly different dates, elsewhere around the world). The same could well happen to Rudd.
Certainly the Liberal Opposition is trying to draw parallels between the “irresponsible” spending of the Whitlam Government and the Rudd Government’s sudden turnaround from a A$20 billion budget surplus to a substantial budget deficit. The mud may well stick, but the real reason for the blowout in the government’s deficit during a recession is the collapse in the private sector’s finances. The mirror-image relationship between changes in the rate of growth of private debt and the government’s fiscal balance is striking–and the leading roll that the private sector’s behaviour plays is obvious. Here, as with money creation as I covered in last month’s Debtwatch, it is the private sector dog that drives the public sector tail.
Government Debt Rises After Private Debt Starts to Fall
The one advantage for Rudd is that this crisis is so obviously global that he can’t be blamed for causing it (though it hasn’t stopped some of the usual suspects from claiming that if only Work Choices hadn’t been repealed, everything would be hunky dory). But his government will be judged by how well it copes with this crisis that is not of its making.
If it sticks with the current course–trying to spend its way out of trouble–then it will fail, because this time the crisis is too big to be papered over. The earlier economic recoveries after the bursting of the 72-74 and 84-89 super-bubbles only occurred because the private debt engine was restarted.
Both bubbles were clearly unsustainable–as noted above, had the 72 superbubble continued, the debt ratio would now be 10,390% (i.e, private debt would be over 100 times GDP). Even the lesser 1980s superbubble, when the ratio grew at half that rate (7.75% p.a. versus 15.5%) would have resulted in a debt to GDP ratio of 380% today.
Bubbles Upon a Bubble
But when these earlier bubbles burst, the debt ratio was low enough to make its restarting feasible–with a different group of borrowers, of course. That is no longer possible.
Disaggregated debt data for the 1973 superbubble isn’t available–though fairly obviously it financed the Sydney property bubble in the early 1970s associated with the name of Frank Theeman (and on the opposition side, Juanita Nielsen).
The 1984 superbubble was clearly directed at business borrowing–and there the obvious names were Bond, Skase, Connell and so on.
The bubble since 1994 has grown at a mere 4.8% per annum–only slightly faster than the overall growth rate from 1964 of 4.2%–as the household sector was targetted by lenders. The trend in aggregate private sector debt masked a growth in the households debt to GDP ratio of 7% p.a., while business debt actually fell, as a proportion of GDP, from a high of 56% in 1989 to a low of 41% in 1995 (the sudden drop in 1989 and the matching rise in household debt was due to a reclassification of some business debt as private by the ABS in 1989).
Lending to Households and Business is at Record Levels
However in 2004, business borrowing took off again–largely as a belated response to the China boom, but also partly due to the now defunct private equity bubble–so that by mid-2008, both household and business debt were at historic highs: household debt was five times the level of the mid-1970s, while business debt was almost three times that level.
There is no-one else left to lend to. With both business and households holding historic levels of debt, much of which was borrowed to finance speculation on asset markets that are now collapsing, the trend in debt will be deleveraging, not further gearing up. So the remedies that “worked” in the 1970s and 1990s can’t work this time round.
Rudd’s A$42 billion stimulus package will therefore be swamped by private sector de-leveraging. If, for example, the private sector tried to reduce its leverage by a mere 5%, it would take A$100 billion out of circulation, more than twice as much as Rudd is trying to add to it.
The real test of Rudd’s mettle will come when these conventional “Keynesian” policies have been tried and failed several times. Will he continue down that track, or will he do what Niall Ferguson this week called upon governments to do instead: not to increase debt by going into deficit themselves, but to reduce debt by resetting it?
That, ultimately, is the only way out of this crisis. Our illusory prosperity of the last 40 years has been the by-product of an unsustainable growth in debt that has been aided and abetted by well meaning but ill-conceived “rescues” of the financial system from its own folly. All these have really done is encourage it to restart lending after each crisis, each time targetting a less and less likely candidate for leveraged speculation, and each time placing a higher and higher aggregate debt burden on the physical economy.
To state the obvious, though this Debtwatch has been about Australia, the phenomenon itself has been global. The debt ratio in Australia certainly exceeds anything in our economic history–it is 2.5 times as high as during the Great Depression and 2/3rds higher than during the 1890s Depression. The US’s debt ratio exceeds its Great Depression peak (which, like ours, was exacerbated by deflation and collapsing output) and is almost twice what it was at the end of 1929; the UK’s ratio is 2.5 times what it was just three decades ago. The same pattern is repeated across the OECD.
The Biggest Debt Bubble of All Time?
Though truly long term data is difficult to locate, this is probably the biggest debt bubble in the history of capitalism. If we are going to survive it, we have to reduce debt–and not merely shuffle it from private books to the public purse. This is a biblical scale problem, and biblical–or perhaps Grecian–scale solution is in order.
I can’t put this argument any better than Niall Ferguson has done (See The great repression and the original post on his blog Beyond the Age of Leverage: Alternative Cures for the Global Financial Crisis), so I will close by quoting him:
There is a better way to go, but it is in the opposite direction. The aim must be not to increase debt but to reduce it. In past debt crises – which usually affected emerging market sovereign debt – this tended to happen in one of two ways.
If, say, Argentina had an excessively large domestic debt, denominated in Argentine currency, it could be inflated away. If it was an external debt, then the government simply defaulted on payments and forced the creditors to accept a rescheduling of debt and principal payments.
Today, Argentina is us. Former investment banks and German universal banks are Argentina. American households are Argentina. But it will not be so easy for us to inflate away our debts. The deflationary pressures unleashed by the financial crisis are too strong (consumer prices in the US have been falling for three consecutive months; the annualised rate of decline for the last quarter of 2008 was minus 12.7 per cent.)
Nor is default quite the same for banks and households as it is for governments. Bankruptcy can be a complicated business. Understandably, monetary authorities are anxious to avoid mass bankruptcies of banks and households, not least because of the knock-on effects on asset prices of distressed sales of assets.
The solution to the debt crisis is not more debt but less debt… banks that are de facto insolvent need to be restructured, a word that is preferable to the old-fashioned nationalisation. Existing shareholders will have to face that they have lost their money. Too bad; they should have kept a more vigilant eye on the people running their banks…
No doubt those who lose by such measures will not suffer in silence. But the benefits of macro-economic stabilisation will surely outweigh the costs to bank shareholders, bank bondholders and the owners of mortgage-backed securities.
Americans, Churchill once remarked, will always do the right thing – after they have exhausted all the other alternatives. But if we are still waiting for Keynes to save us when Davos comes around next year, it may well be too late. Only a Great Restructuring can end the Great Repression. It needs to happen soon.
Meanwhile, Back in the US of A…
The figures coming out of the USA now are both staggering and entirely predictable. Their debt bubble’s burst is further down the track, and the devastation of the economy is evident. The tracks of the debt elephant are obvious (see Tables 3 and 4 below). Unemployment has skyrocketed to 7.2 percent, GDP is now falling at an annualised rate of 6.2 percent, and the US stock market indices are now back to where they were 12 years ago. This is no ordinary crisis–though the Obama Government is still trying conventional means to overcome it.
Debt Dependency in the USA
Change in Debt and Unemployment Correlation in the USA
Rolling Ten Year Correlations
There at least Ferguson gives us some hope. As he reminds us, “Americans, Churchill once remarked, will always do the right thing – after they have exhausted all the other alternatives.”
END OF COMMENTARY
Comments on the data
Though there was a slight increase in the rate of growth of debt over the last month, it was still below the rate of growth of nominal GDP–so that the debt to GDP ratio contined to fall from its peak of 165% set in April of 2008 to be more than 5 percent lower now at 159.7%. The danger is that the fall into deflation that has already started in the USA will be replicated here, so that the debt burden will rise as both output and prices fall faster than individuals can reduce their debt levels.
Aggregate Debt Data
The one component of debt that has fallen consistently for the last six months is personal debt. However at the same time credit card debt is rising. The implication is that, while households are largely unable to service their credit card debt, they are no longer taking out consumer credit from the “Buy now, no interest for 3 years” brigade.
Disaggregated Debt Data
Co-movements in Debt and GDP over the long term
March 2nd, 2009 at 9:39 am
Thanks very much Steve. Funny this should get posted today. Just yesterday evening I was discussing the Whitlam years with a good freind, a Scot who emmigrated here about 10 years ago. I was telling him about the financial chaos of that time and the utter mess Gough left in his wake.
As an aside on the Labour party, I couldnt help noting a quote from the Weekend Aussie;
“…whenever Labour get’s in, we all go broke!”.
Indeed. The GFC was not caused by Labour , but their response in burning through Billions of public money IS their responsibility.We have yet to see the ramifications of that.
March 2nd, 2009 at 10:07 am
Thanks Steve, for another pellucid piece of work you have created.
GSM
I’d rather have a progressive government in, . The might just be able to do what’s needed and have a heart at the same time.
Fingers crossed they read your article Steve and have the resolve to live up to their title.
Still would love to know a definite time scale of how long it would take this to wind out if we don’t take the ‘debt moratorium route’. Anyone?
March 2nd, 2009 at 10:17 am
Steve,
Could you express your thoughts on the magnitude of influence the US has in Australia’s fortunes going forward? I believe that by far the primary determining factor for Australia’s economic future will be determined by the events as they unfold in the US (rather than pump priming and debt forgiveness/ write down by KRudd). If the US, 25% of world GDP, cannot turn itself around there seems to me little hope at all of a lasting global economic recovery taking hold. Australia’s propserity is largely underpinned by global factors, none bigger than US GDP.
Your thoughts on this?
Many Thanks.
March 2nd, 2009 at 10:24 am
Hi Steve,
What is the right hand scale of the figure”Lending to Households and Business is at Record Levels”?
What is trace 3 in the figure “The Biggest Debt Bubble of All Time?”?
Good Post!
March 2nd, 2009 at 10:33 am
Steve,
It seems that you have accepted that the government will keep doing the wrong thing for a while. This is sad.
Maybe we should start sending them messages like: Want to stay in the history books in 2600 years? Go for http://en.wikipedia.org/wiki/Seisachtheia
March 2nd, 2009 at 10:43 am
Whoops!
The right hand side of that figure is the same as the left hand side–debt as a percentage of GDP–but the scale is different. 50% on the LHS corresponds to 100% on the RHS. That lets me add the two separate data series for business and household debt and still show their ups and downs accurately. When I put all 3 on the same axis, the variations in the business and household components aren’t as obvious.
And “trace 3″ is the UK! I’ll fix that up now.
March 2nd, 2009 at 10:54 am
That’s generally true, but even without the USA, we have a debt bubble whose collapse could cause unemployment to rise to well over 15%. The added problem from the fact that this is a global crisis, and that the USA is one of the worst offenders, is that there can be no “rescue from Mars” to save us.
This was a large part of why Japan didn’t do worse during its long-running Depression: even though domestic demand was crucified by its domestic debt problem, it could still export to the rest of the OECD–and America in particular–as their 90 downturns were reversed by a renewed debt bubble starting in about 92. Now that the rest of the world has caught up with Japan in reckless and ultimately futile debt-financed asset speculation, that export avenue for sustenance has been removed from its economy and it is therefore plunging.
We will face a similar problem–in fact since the rest of the world entered this downturn before us, the bursting of our export bubble (such as it was) will be one of the initial triggers for the downturn here.
So we aren’t going to be rescued by the US Cavalry this time.
March 2nd, 2009 at 10:56 am
Hi all
I was talking to someone I know who works in the Dept. of Housing in NSW. He said that Rudd’s package is sending a lot of money their way – they are calling it ‘The Surge’.
During the course of the conversation I mentioned to him my concern that part of the motivation behind all this money was to help maintain property values. He said that they have been getting developers calling them asking them to take on building projects that he suspects are in trouble. He thought that this was might be a good thing as otherwise the projects wouldn’t go ahead and if the ‘buy’ them then the properties would end up as public housing. I want to stress that he didn’t say how many – if any – would be actually purchased.
I suggested to him that if they waited 12 months they could probably use that money to buy a lot more housing stock if the market continued to fall. I urged him not to pay too much now.
He then smiled, shrugged and said,
“How much is too much?”
I want to make clear that I think that this is a good man trying to do his job well. But I despair to think of all this money that could be used for genuine public good actually being used to prop up the price of unaffordable housing – all in the name of providing housing for people who cant afford it!
March 2nd, 2009 at 10:58 am
I certainly think this is what is going to happen globally. There is even a move in the 10 and 30 year treasury bond chart between October and now, that is identical to 1971 when Nixon closed the gold window, it’s amazing how similar the treasury bond chart is to around 1970-1971. Now real estate prices in Norway have risen for the second month this year, and the bubble in Norway was huge, around 230-250 if 100 is the norm, not as bad as in the UK, but certainly as bad as in the US, however without the supply. Sugar is just going up and up, it’s certainly inflation that’s coming.
March 2nd, 2009 at 11:05 am
Thanks Steve for yet another marvelously facinating Debtwatch newsletter.
One point I would like to make about inflation, I look at the Rudd stimulus package how it would be offset if the private sector tried to reduce its leverage by just a few percent. On the surface that makes it look like inflation can’t happen. However, capital, hence goods production is declining at the same time due to unemployment and reduced production from companies folding etc. So what you have is the same population fighting/bidding for a reduced supply of certain goods and services they need to survive, so it wouldn’t surprise me if many sectors of the economy experienced strong inflation, although the figures for the whole may not reflect that due to the “weighting of the basket”.
- Ernie.
March 2nd, 2009 at 11:18 am
Commenting on your previous post, “Bravo Niall Ferguson”, ‘Not an optimist’ (6:57 pm) wrote;
“Niall Ferguson’s article refers to a “restructuring” of the insolvent banks as part of the answer, but doesn’t address the question of how such a restructuring would remove the bad debt from the system.
Thus, this doesn’t really seem like a “solution” to me – either the government itself has to pay back the bad loans (with potentially far reaching consequences for sovereign risk), or the bad debt has to be crystallised (with consequences a la Lehman Brothers).
Am I missing something here? Or is even this article still trying to make things appear to be better than they really are.
In this respect, I also note that his article doesn’t refer to cancellation of mortgage debt, merely to resetting loans to lower interest rates and longer maturities. So, a long slow decline rather than a sharp and quick decline, but a very substantial decline nevertheless.”
These seemed to me to be interesting points, but elicited no response, neither from yourself nor (unless I missed it) from any other commenter. In this post you state that what governments need to do is “not to increase debt by going into deficit themselves, but to reduce debt by resetting it.” Echoing ‘Not an optimist’, what does this resetting actually involve and how does it reduce debt? I’m not arguing, I don’t understand what it involves and would appreciate your explaining what you mean.
Still puzzled by your enthusiasm for the pronouncements of members of the commentariat when they finally spot what many, including yourself, have seen coming for some time. Anatole Kaletsky, to whom you awarded brownie points recently for his renouncing his faith in orthodox economics, appears to have reverted to type. In his latest article he sees “the need to channel public money, potentially without limit [!], into whatever measures may be required to support the banks” otherwise it will mean the-end-of-civilisation-as-we-know-it (or “the end of 200 years of market-based capitalism throughout the world”, which is apparently the same thing.).
A habit of members of the mainstream I’ve noticed is that, having spotted a bandwagon rolling, they will hop smartly into the vanguard, hoping to convey the impression that they’ve been there all along. Am I suggesting that this is what Niall Ferguson is up to? As the man said, you may think that; I couldn’t possibly comment.
March 2nd, 2009 at 11:25 am
Hi Doggett,
I may have to confess to excessive generosity! I even gave Ross Gittins a tick once, though at least there I tempered it with am acknowledgement that he was a weather vane rather than a seer “Ross Gittins finally comes aboard“.
Ferguson however may be more substantial. I have yet to read his magnum opus on money, but that alone implies that he has a more substantial basis for his arguments and position than a commentator like Kaletsky.
Journalists like Stephen Long of the ABC, and Michael West of the SMH, who have always been aware of the debt problem and have consistently stuck their necks out about it even when it was unfashionable, are a much rarer and more valuable breed. But I still like to at least acknowledge when a weather vane has swung with the most recent breeze.
March 2nd, 2009 at 11:37 am
So, going forward does one then set interest rates based on levels of debt? Because setting rates against CPI levels certainly hasn’t helped control/prevent debt bubbles from repeatedly occuring.
March 2nd, 2009 at 11:45 am
Hi Steve
If you get the chance would you be able to do a post [or comment] on how a debt write down could be achieved – including your thoughts on how to make it as fair as is reasonably possible? I am interested to know if this could be done country by country or would it need to be internationally coordinated?
On a second point Mish has written a great article on how he sees the debt issue playing out in the U.S banks:
http://globaleconomicanalysis.blogspot.com/2009/02/who-bears-burden-for-3trillion-mistake.html
March 2nd, 2009 at 12:39 pm
Hi Steve
I have been following your site with much interest for 2 years and have a lot of other Western Australians becoming converts.
Your “debt dependency graph” has interesting implications. If debt forgiveness is not chosen as an options as the only other long term option for restoring “manageable” 35% debt to GDP ratio from our current 150%, a choice of:
* 15 years of 8% annual reduction in debt with 11% unemployment.
* 10 years of 11% reduction at 12% unemployment.
* 8 year of 15% reduction at 14% unemployment.
or some other combination that can be inferred by the chart.
If so no democracy can ever achieve that as a snakeoil selling alternative government will make promises that will result in the dismissal of any government with such a long term solution.
It seems that the debt figure has grown to a level at which there is no solution under a democratic society.
Perhaps not only capitalism as we know it but democracy as we know it is unsustainable. I would appreciate your comments.
(A related future problem may be funding the “repurchasing” of privatised assets that have been rundown and bleed dry by merchant banks who can no longer fund maintenance and development, if they ever did. I would appreciate a comment on the potential problems in that area in some future blog)
March 2nd, 2009 at 12:51 pm
I fear I will be re-reading this post a few times…
“The danger is that the fall into deflation that has already started in the USA will be replicated here, …”
But that graph of the 1970s experience gives one pause for thought.
I accept that the bursting of a debt bubble causes great disruption, but the consequences of the disruption seem far less certain. Correct? Or are there some likely scenarios from here for Australia?
March 2nd, 2009 at 12:59 pm
Another great article Steve.
How anyone can look at the underlying data and not conclude we are in for some very hard times is beyond me. Whichever way you look at it.
While in the past it was possible for some countries to revitalise their economies using the methods they did & are now trying again, but this was only possible due to the smaller sums involved and the crucial fact other countries were still in the so called “boom”. When the US, EU & Japan all try it at the same time it can’t possibly work, can it???
March 2nd, 2009 at 1:10 pm
Ummmm, not wanting to discount the contribution of excessive debt, but didn’t the oil crisis of 1973 contribute to Whitlam’s economic woes? Similarly, didn’t the oil shock of 2008 contribute to the onset of recession last year?
Perhaps the credit bubble created the oil bubble?
Yes, there are striking similarities between the Whitlam era and today, but I don’t think it will result in stagflation this time, more likely a Japanese-style “lost decade” (or two).
March 2nd, 2009 at 1:36 pm
Thanks for the response Steve.
At the least, I’m pleased that I’ve managed to interpret the data the same way you are.
March 2nd, 2009 at 2:25 pm
From a Minskian point of view, the oil crisis and the wages push both reduced the impact of the debt crisis by drastically devaluing debt and reducing the real cost of debt servicing to below zero. So yes they contributed to the overall feeling of economic chaos, but without them we might have had a sharper recession.
Frankly we would have been better off had we experienced that then–it might have nipped the tendency to accumulating debt in the bud. But we didn’t, central banks obsessed with driving inflation out of the system, and after a sustained period of deliberately depressed economic activity (but with rising private debt all the same), we arrived in today’s hyper-debt, low inflation world.
And yes, a lost two decades is quite feasible.
March 2nd, 2009 at 2:28 pm
Hi Marcus,
They’re reasonable but probably optimistic extrapolations; if you factor in compound interest on debt even at 3%, plus possibly serious deflation (heaven help us if we hit the 1930s level of 10%), then the matching unemployment projections have to be revised substantially upwards. And we will also suffer from a seriously depreciated capital structure and a halt to innovation, as you surmise.
March 2nd, 2009 at 2:38 pm
Hi Steve and others,
Do you expect the Nationalization attempts by the US to work as in the case of Roubini preaching or are you in favor of let the old banks go broke and die and let us start up new banks?
If yes or no please explain.
What about here in Australia? When do you expect our banks to cave in and be claim to be broke?
Do you expect a nationalization attempt here too. I think we always follow the US so this will be the case here.
Does anyone have a clue whether deposits are guaranteed under nationalization?
March 2nd, 2009 at 2:44 pm
Great article.
Thank you.
Are we now in a period of deflation or a temporary fall in prices or disinflation?
When i here news of our tankers of iron ore parked off China, i tend to think we maybe in for some deflation.
I don’t have an economist or financial background, my work involves developing commercial and industrial properties for A-REITS. This industry has been smashed with many of my colleagues laid off.
Values (or should i say prices) have fallen in this sector by at 25% to 30% and still falling. With the ban on short selling financials ending soon, i expect to see more blood.
Strangley if anyone did have any capital to spend on large property no one knows how much to pay for it. So everyone sits on the sidelines waiting to see what happens.
I’m also in the middle of selling my house in Southern Sydney to remove my debt before the beast eats further into my own personal equity.(hope i’m not too late).
Don’t suppose that Greek law ‘Seisachtheia’ would actually come into being?
Nup didn’t think so either.
Is this also referred to as a Jubilee?
I appreciate websites like this and others and have seen Steve Keen name in other economists websites of which Steve is held in high regard.
So thank you Steve for your efforts here and allowing me to broaden my knowledge of a complex (to me)issue.
Now i understand (broadly) the money vs debt supply issue and how we are in this position of contracting credit and importantly how this time it’s different and part of a bigger ball game than previously experienced.
Also would i be right in saying i shouldn’t expect inflation to be an issue for around 2 to 3 years? Possibly much longer? after the impending Australian crash, as banks maybe sitting on reserves and not wanting to lend money?
Now I’ll get out of the way and let you economic intellects get on with the job.
Kind regards
Mike
NB: SK are you known as ‘mred’ on another site?
March 2nd, 2009 at 2:58 pm
Steve
I disagree with your thesis that inflation now would be a good thing. Many people that speculated on realestate and the stock market did so because of they of the unending depreciation of their savings brought on by credit inflation. I also dont take seriously numbers that proclaim that inflation which in its technical sense is the supply of credit, has been stable over the past decade. On the contrary we’ve had hyper-inflation in many asset classes but of course government figures dont reflect this as it discounts these asset classes; ie. houses.
What countries needs more than anything is a stable currency and this comes about by keeping bank leverage at around the 10 mark. Gold is doing well becuase of the lack of trust is paper money.
As for price inflation! Prices are determined by supply and demand which in a simple sense is:
Price=(Money in circulion)/(Goods produced)
In a deflationery environment the denominator falls in a linear manner where as the numerator decreases in a 1/x manner as credit is tightened and loans default.
I would instead favour a stable currency above all else. This would reduce the need people see for speculating.
I would also like to say that I am in favour of Australia having an honest depression and not a Great Depression. To see why its necessary we need only look at the size of the financial sector of the economy relative to the Real economy. At 40%+ its unsustainable and I would have no quarms about having these financial types doing real work; growing veges, polishing shoes or whatever – so long as its productive. Intersteing to note that Australia consciusly took the path of growing its financial industry over more productive enterprises – also intersting that financial types refer to what they do as an industry – its an oxymoron. Welcome to scamsville.
March 2nd, 2009 at 3:17 pm
This site is getting too hard to follow. I’ve only been away for 3 days and there has been over 200 comments.
I read the Ferguson article and I too was a little disappointed. I was happy to read that he acknowledges that the answer is debt reduction and not increasing debt. Great! We on this site and a million others have realised that.
What Niall doesn’t tell us is how to reduce debt though. He just says it must be done. He then goes on to say that rates must be reset lower (does he mention 3%?). That sort of price control does not work. Banks can only lend money if they can borrow it for less. Shops can only sell goods if they can buy the goods for less. Artificial price control is a theoretical dream.
The best way to get rid of debt is through bankruptcy. When that happens a stronger hand comes along and buys or picks up the pieces. Life goes on. There is a lot of pain of course, but business and humanity gets a chance to start over.
At present, there is bailout after bailout. The stronger hand can’t compete with the bailers (even stronger hand for the moment) and so the efficient system is being distorted.
Good post Steve, The lagging link between growth or decay of debt and unemployment is massive. I wonder if Michael West is reading and he will write on this subject. Wow!!!
As debt deflates, and it hasn’t even started deflating yet. Unemployment will skyrocket to 20+%. Ouch.
March 2nd, 2009 at 3:33 pm
Bullturnedbear said
“The best way to get rid of debt is through bankruptcy.”
Correct, and it puzzles me that new words are being used, like debt forgiveness, to describe the obvious. Anyform of debt reduction for one party translates into a loss to another party. I’ll be dammned if some gov official or otherwise sets themselves up as judge jury and executioner is this regard and ignore 800 years of common law.
March 2nd, 2009 at 3:50 pm
I think you are absolutely correct Bullturnedbear ;
“At present, there is bailout after bailout. The stronger hand can’t compete with the bailers (even stronger hand for the moment) and so the efficient system is being distorted.”
KRudd is prepared to sacrifice the evil capitalist system, and Australia’s wealth now and in future, in order to avoid the various negative numbers that could see him voted out of office (unemployment, bankrupcies, foreclosures, GDP etc). This is the great gamble of course, but it fits entirely with the “collectivism” philosophy of his party. The big gamble is that KRudd runs out of OUR money (or market forces force his checque writing hand) before globally and specifically the US can turn this Depression around.
March 2nd, 2009 at 3:58 pm
Steve,
What is your opinion of what Jim Roger said in this interview on dateline:
http://news.sbs.com.au/dateline/interview_with_jim_rogers_563581
March 2nd, 2009 at 4:11 pm
http://www.financialsense.com/fsn/main.html
Have a listen to the 2nd Hour with G. Edward Griffen. This is US centric but I think you can easily identify KRudd’s (and Obama’s) strategy to grow Govt in order to first plunder the wealthy (redistribution of wealth) and muster the population towards a “nationalized” type of economy , centrally controlled, as some commentors here seem to favour.
This however entails significant loss of freedoms and individual will. Totalitarianism in short. A very interesting take on the sea change in politics taking place and the direction it can lead us.
March 2nd, 2009 at 4:11 pm
This depression is only just beginning. Some of the export numbers coming out of Asia are insane.
I nearly fell over when I read a month ago that Japanese December exports fell 35% compared with Dec 07. Then last week the January figure came out. Down 46%. What? that must be a misprint. Who are Australia’s two biggest trading partners? China and Japan. Australia is not only up the creek without a paddle. The creek is in flood.
Asian economic growth will go into decline. Even China will have deflation because of massive excess capacity resulting from asset and production speculation.
The talk of inflation is delusion. It must be some scam (or eternal hope) thought up by stock market players so far in the hole that they need to keep conning people to buy buy buy in the hope they themselves can get out.
When loan arrears rates are rising exponentially (in the US and Europe), exports are crashing (all around the world), unemployment is rising (all around the world) and consumer confidence is falling to historically low levels. The writing is on the wall. Brace yourself for financial pain heaped up with social mayhem. Massive deflation not inflation for the next 2 years. We will just have to wait for the Tsunami to begin.
I think the Obama 6 months for banks to meet capital adequacy standards is interesting. Another tool to try and push the problems down the road hoping for a correction to start. Denial!!!
March 2nd, 2009 at 4:47 pm
Steve Keen wrote:
Well Steve, I reckon you’re in a tiny majority who think the 1973 oil shock resulted in a recession that was milder than it otherwise would have been. There are plenty (er, like just about everyone else really) who think the oil shock was the primary cause of the 1973-74 recession and subsequent stagflation.
But I guess you’re used to being in a tiny minority
Again, I don’t want to underplay the role of debt in recessions and financial crises, but there are other things happening in the world as well (like, er, peak oil). It can’t be all debt, debt, debt, can it?
March 2nd, 2009 at 4:51 pm
BTB wrote:
I think you’ll find we’re different to the rest of the world, we’re very resilient, and we’re actually immune to the GFC. Just ask Bill Evans or Craig James.
March 2nd, 2009 at 5:46 pm
The difference between the two parties is very simple. Labor has always believed that debt is good, whereas the Liberals have been a bit worried but have seen it as a way to buy an election. Most of the Labor party are now happy that they don’t have to maintain that “awful” surplus, the one they took every political advantage from.
March 2nd, 2009 at 5:54 pm
http://www.financialsense.com/Market/wrapup.htm
A very pertinent and insightful review of the US consumer and the awful 4Q08 US GDP numbers.
“So we aren’t going to be rescued by the US Cavalry this time.” Steve Keen.
Amen!
March 2nd, 2009 at 7:15 pm
Hi Steve,
Very insightful article, I like the political context as well as the represantation of your theory in the data.
I want to point out that without the political context the style of analysis is exactly what I see from the market economists. So it’s interesting for me to contrast the two similar approaches. Firstly, because market economists work in dedicated teams, they are able to churn through many more factors, but the style of analysis is the same. Also there is no link to theory, I think mainly because the intended audience are traders who generally have a short economic horizon so mainly need to know what is happening with a very short turn around in the relay of this information, rather than what is going to happen in the long term. Before you draw the inference between trading and speculation I would like to point out that speculators would need a longer economic horizon as opposed to market maker traders.
So I’ve seen a similar analysis and would like to suggest a couple of points. As you stated correlation does not imply causation. I would suggest that causation in one country also does not imply causation in another country. Also potentially causation changes direction with the direction of the business cycle. I’ve delibaretely left out the details so you can draw your own conclusion.
I would like to finish with a hypothetical. Let’s say we knew about what is going to happen 5-10 years ago, what would you do. From my perspective, realistically the only people who can put a stop to excessive debt are the regulators. People will tend to borrow what they can and banks will tend to lend what they can as long as they perceive it as profitable.
March 2nd, 2009 at 7:17 pm
http://edition.cnn.com/2009/BUSINESS/02/27/japan.recession.jobs/index.html
BTW – Today’s company profits took the markets by surpise, the expectation is now for negative GDP growth in QIV
March 2nd, 2009 at 7:54 pm
GSM,
I only skimmed through the article but I think it’s worth mentioning the US consumer spending to GDP ratio is from memory around 70% as opposed to 55% in Australia which I think is about average. That’s a very tall mountain to fall from for the US, and I’m starting to think they are going to drag everyone else down with them.
I still claim that the high debt in Australia is going to hurt, but without it we would be screwed anyway.
March 2nd, 2009 at 8:41 pm
jc1
This makes me furious. My brother, up till recently, was working for one of the biggest property developers in Europe. His job was to find and acquire projects for the country where I live.
The property developers are in bed with the banks. New builds have all but completely stopped here, because the developers can’t get the debt/equity ratios from the banks to make it worth while and because by stopping they hope to cause artificial scarcity in the higher end of the market. The problem there is that the banks have a lot of money in big projects all around the country.
If the government is sending money to the property developers, it’s just another roundabout way of protecting the banks.
March 2nd, 2009 at 8:46 pm
An interesting article. I remember growing up in my teens in the Whitlam years and developed a strong interest in politics and economics at that time. A strong conservative outlook was developed at the time, both as a consequence of the Whitlam years and rural background. This has been tempered over the years as the damage that unrestrained greed can cause between more and more apparant.
I personally would think that the bursting of the debt bubble at the time was a result of economic uncertainly from the high inflation, oil shock, high wages growth of the period, part of which can be attributed to the government of the day.
However todays problems are clearly the result of the debt crisis and we need to have a process in place that reduces the debt burden and then policies to prevent it reoccurruing. Some form of debt forgiveness / bankruptcy must be used. I would suggest this be used with prudent printing of money to at least partially compensate for the destruction of money / credit caused by the bankruptcy / debt forgiveness road.
How to prevent it in future. Possible ideas
1. High reserve requirements for all banks and financial institutions. In excess of 10%?
2. Setting of official interest rates to be based on growth of debt. Increasing debt as proportion of economy would result in higher interest rates to cut off the trend before it takes a significant hold on the economy.
Would point 2 result in excessive currency strength and damage the real ie productive economy. If so, are currency controls required and can they work in todays globalised economy.
Does all the world need to move away from floating currencies to currency and capital controls?
More and more the problem is clearly seen. Some ideas for short term solutions are clearly apparant.
However I have seen very little which satisfies me as to a long term solution to the structuring of the Australian and world economies for long term growth and improvement (or maintenance) in living standards across the world. And this is the part that I am particularly interested in.
March 2nd, 2009 at 8:49 pm
BTB
In the UK there is a lot of talk about asset deflation coupled with CPI inflation.
The actual index data for the UK shows CPI deflation for the last 4 or 5 months,but the suspicion there is that this is down to the oil price drops, and that Sterling devaluation will drive up CPI. People in the UK seem to be complaining of price increases of basic goods. I myself am skeptical as there is a psychological element to perception of prices that requires one to go to hard data.
The reasoning seems to be that as the government takes more ownership of the banks, it takes on the foreign debt liabilities. The UK has some trillions sterling foreign liabilities in the private banks I think, and the assumption is that this will somehow drive Sterling down.
Also the UK being heavily focused on financial services makes it a net importer as the finance sector crumbles.
This talk of inflation in the UK seems to be specifically to do with CPI resulting from currency problems.
March 2nd, 2009 at 8:53 pm
carbonsink
It’s this whole minority/majority mindset that ‘democracy’ (in its present form) that is the problem. What we need is a *meritocracy*.
Really, why should we care if 99.9% of the people have opinion X if they know sweet FA about what they are talking about?
March 2nd, 2009 at 9:10 pm
That the oil shock was the reason for the stagflation is wrong, and leads the spotlight away from the culprit, the federal reserve. It was the expansion of credit before the oil shock (that lead to the rise in the price of gold), that simply made oil worth more because there was more money in circulation. The oil shock, brought oil back into a normal relationship with gold. Before the oil shock this relationship was around 35, (right now this relationship is around 25, so there is some similarity. The norm over time seems to have been 15, but it seems to be sliding over time.
March 2nd, 2009 at 9:15 pm
Personal consumption up for the second month in a row in Norway. It actually appears as if consumers are taking the low interest rates, once again. I thought this last boom was the last blast, but it’s actually ticking up, both house prices and personal consumption. The commentators are all in the doom gloom mood, and completely ignore the numbers. But numbers are numbers, and it’s certainly interesting. In Australia interest rates came from a much higher level than here, so I would think it certainly would be room for another boom if rates were pushed low enough.
March 2nd, 2009 at 9:18 pm
Frank,
Your playing with a dangerous notion there, and I hope you are not arrogant enough to think you know better than 99.9% of people.
On that note however, one take on the events leading up to the crisis is that China was flooding the US with money, and the investment banks literally didn’t know what to do with all that cheap capital, hence the invention of sub prime.
So was China (not a democracy) doing this out of ignorance you think?
March 2nd, 2009 at 9:25 pm
One thing I find fascinating is that the US dollar have weakened when oil have strengthened, that relationship held up until 2 weeks ago. The last two weeks oil and the dollar have been rising together. It’s weird, but I think it’s a certain possibility that the US economy is strengthening. There is no other sign that gas prices are rising, and fuel usage is increasing.
March 2nd, 2009 at 9:29 pm
Is there anyway changes in house prices could be included in CPI?
Surely now, we can say that if this was the case interest rates would have spiked years ago stopping the boom and consequential debt burden
March 2nd, 2009 at 9:33 pm
TITINT,
Yes, US consumer spending makes up more than 70% of their GDP. The scary part is that on average since 2000 , almost 2/3rds of US consumer spending has been financed from MEW (mortgage equity withdrawals). That has now of course disappeared and is going negative as US citizens save aggressiveley and households de-lever . The US economy has slammed into reverse and no ammount of pump priming will stop it until consumers feel safe. This will be a several years event.
March 2nd, 2009 at 9:37 pm
GSM, are you sure about that? In the latest survey, inflation expectations rose to 1,9 % year on year, from around 1,7 % I think the month earlier. If that trend holds, then they should start to borrow because of inflation fear, right?
March 2nd, 2009 at 9:38 pm
Oil price at the moment is a fair way below marginal cost of bringing new oil to the market, not that oil production is at full capacity at the moment. I think its a pretty speculative market as most futures are, so two weeks is probably not long enough to call a break from previous correlation relationship.
Every piece of data coming out of the US is pretty dismal, I think two week fluctuations in oil are more likely to be speculators repositioning, I’d probably go long oil at below $40.
March 2nd, 2009 at 9:49 pm
No it can’t carbonsink,
But it’s part of the dynamic that other thinkers (those not inspired by Hyman Minsky) leave out, so I emphasise it. And when you have a debt bubble, then it drives almost everything else too.
One of the factors that gave rise to the inflation of the early 70s was that the real economy really was booming. Unemployment had been below 2% for ages, thus strengthening wage bargaining power and the rate of growth was putting pressure on oil supplies while they were being underpriced by the oil majors. So those two “real economy” factors were in the wings when the debt bubble took off.
It then supercharged both of them, leading to an inflationary surge at the same time as the asset price bubble fuelled by the debt started to tank.
Do have a look at Minsky’s theory though, as I explain it on the “Finance and economic breakdown” link on the Research page here, or in my lectures on Financial Economics on the http://www.debunkingeconomics.com site. You will see that he, like Fisher, saw inflation as a mechanism that could make a debt crisis less severe–which is the case I was making about 1973-5.