Debtwatch No. 32: Is Rudd the new Whitlam?

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 A quick quiz: when did Aus­trali­a’s biggest pri­vate debt bub­ble burst?

A young Gough Whitlam

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

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

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.

Whitlam's Deficit Blowout

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

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

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

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.

Debts contribution to demand exploded and then collapsed

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

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

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

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

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

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

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.

Growth Rates of Australian Private Debt

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

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

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

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?

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

Debt Depen­den­cy in the USA

Change in Debt and Unemployment Correlation in the USA

Change in Debt and Unem­ploy­ment Cor­re­la­tion in the USA

Rolling Ten Year Correlations

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.”


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

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

Dis­ag­gre­gat­ed Debt Data

Co-move­ments in Debt and GDP over the long term

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About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.