The last quarter’s GDP figures, showing that Australia’s GDP contracted by 0.5% in the last quarter, ended the “phony war” debate over whether we’re in recession. The previous quarter’s 0.1% was so close to zero that it’s semantics to question whether we’ve seen six months of negative growth or not: we are in a recession.
Now that we’ve had our Dunkirk moment, it’s time to consider what policy should be, given that avoiding a recession is no longer an option.
A first step there is seeing why we recovered from previous recessions, and asking whether we can pull off the same trick again this time.
My answers are that our escape route from previous downturns was to renew the private lending engine, and that this is a trick that is one recession past its use-by date.
The 1990s recession saw private debt to GDP ratio top out at 85% in late 1990, and then fall to 76% by early 1994. From then it took off once more, with households taking over the borrowing binge mantle from business, which actually reduced its debt level from 56% of GDP to 40% in mid-1995. The household debt binge, which began in 1991 in the depths of Keating’ recession, took the household debt to GDP ratio from 30% to a peak of 99%, from which it is now falling.
Meanwhile, business borrowing likewise began a China and Private Equity fuelled blowout in mid-2004, rising rapidly from 46% of GDP to 66%–a new record–by early 2008. The combined debt total reached 165% of GDP in March 2008, and it has since fallen to 160%.
So what are the odds of encouraging businesses or household to start borrowing again, from their now record levels of debt?
Not good, I would think. Instead, they will be de-leveraging, not just for the duration of a standard recession but perhaps for a decade or more, to bring debt levels back to something like 1960-70 levels of 25-50% of GDP. Deleveraging has only just begun, and it has a long, long way to go.
So we can’t encourage businesses to borrow, or households. Who else does that leave?
And the bingo award goes to Kevin Rudd: government can get into debt instead. That is what is now happening of course, and from a position in which the government’s debt to GDP ratio is currently close to zero. So it has capacity to borrow and thus boost demand, but how does that weigh up against what the private sector might do in the opposite direction?
Not well. Rudd’s stimulus is a whopping $42 billion–a big number. But our private debt is now over $2 trillion. If the private sector de-levers by as little as 5% of its current debt level, that will withdraw $100 billion from spending. In the new economic Rock vs Scissors game, Deleveraging trumps Government Stimulus every time.
This is why Japan is still mired in a Depression, 19 years after its bubble economy burst. You can’t solve a problem caused by too much debt by going into more debt. Ultimately, the only solution is to reduce debt.
There Australia is in a quandary. We don’t yet have insolvent banks–the USA on the other hand has nothing else. So drastic means of attacking the problem are possible in America, once the Yankees get over their usual pussy-footing about nationalisation. But we can’t follow that path while it still appears that our banks are solvent.
So all we can do is brace ourselves for a massive increase in unemployment, and do what we can to ameliorate the pain. Several policies are obvious there: remove the waiting period for receiving the dole, eliminate (or drastically prune) the requirements that unemployed persons exhaust their savings before they receive the dole, get rid of the punitive job application requirements, and take the stigma away from being a victim of a global financial crisis that is well beyond the control of those whose jobs will be destroyed by it.
That will necessitate a massive increase in the government deficit, but that is justified in making sure that the pain of a Depression is shared more equitably. It is also a far more sensible way of going into deficit than throwing a fistful of money at soon to be unemployed consumers.
We can also change the rules on mortgage defaults, so that a failed borrower becomes a renter from the bank or lender that extended the money, and pays a rent based on a proportion of their income. That might mean a lot less revenue for banks, but it will also mean a lot less mortgagee sales–and there will be a tsunami of those coming our way if the economy continues to shrink by 0.5% or more every quarter.
On that front, the most recent figure was a drop in the bucket compared to what we’ve already seen overseas, and what we are likely to see here as deleveraging reduces debt-financed spending, our terms of trade collapse, and our export voumes plummet. It seems that the days of Kangaroo Economics–”We won’t suffer a recession because we have marsupials”–are over. Bye Bye, Boom Boom.
bullturnedbear -
I’m not all that fond of work – are you? All the jobs have gone to China anyway.
The social crediters argue that production isn’t the problem. The firm model is so unbelievably efficient that scarcity is artificially contrived by the financiers to keep a dinosaur breathing.
Why should the banks make such a great unearned profit?
Hi Macca,
I believe the increasing levels of deficit spending will be gone some time next year for two reasons.
1. When the people of Oz see that trade, jobs, wealth and lifestyle has collapsed they will demand that the government be cautious and careful with their money. Government is apart of the same herd.
2. Government tax revenue will crash next year. When it does the government will be increasing their borrowing just to keep spending at the previous levels. Let alone increase spending. I believe that process will continue until the government is forced to cut spending very hard. Some of the cuts I expect are.
Cuts to pensions and the dole.
Cuts to government wages and government employment levels.
Calls for all departments to cut spending and put off projects.
Hi Bullturnedbear;
Yes indeed, and that would be after the next election. Too late then for those truly in need, with our wealth squandered.
Economics, while being the principles behind the GFC’s genesis and unfolding, now take second seat to the politics of Gov’t spending.
The GFC is now (and likely to be) the biggest political event of our time.
MACCA
You said “Very VERY large percentages of national GDP will be debt financed”.
This has been the case for the last two decades at least and is the cause of the problem. The only difference (from what you suggest) has been that the debt has been taken on by the banks and households and not the governments.
Increase in debt has exceeded GDP growth for quite a long time. You could say that GDP growth has actually been negative because of this growth in debt particually as now the “asett backing” has been seen to be non existant.
The fact that this debt increase rate, became non sustainable triggered off the current collapse. It is now also obvious that the actual debt levels are not sustainable.
This occurred in 1892, and 1932, and is happening now.
I would contend that this collapse marks the end of financing of GDP by debt (until the next run up to depression). The collapse will continue until this is resolved by government action, or, as seems more likely, resolves itself.
Warren Raftshol said
“I’m not all that fond of work – are you? All the jobs have gone to China anyway.”
Well you had better get a taste for it because the Chinese wont be doing the bidding for you. If you want good health care, plazma tvs and fire engines then you need to work.
This attitute is at the core of our problems. We not only do nothing but we expect others to do it for us. On top of the entitlement class just ‘wanting’ we have a uber-rich financial and political elite that continues to rape the real economy and they have done this by fooling the masses into believing in FREE money.
It seems that people only learn one way – and that’s the hard way.
BrightSpark1,
The US already has racked up commitments in stimulous and others to the tune of 12% or more in GDP. UK is headed in that direction fast. Australia is nowhere near that level of debt- yet.
You posted”It is now also obvious that the actual debt levels are not sustainable.” Unfortunately, I dont believe this to be true at all. Obvious to some , yes. For a long time. A minority though to be sure and certainly none in Govt.
We regularly see many prominent Keynesian economists- who have the ear of Govts these days, urging yet even more spending and much higher levels of Govt debt. Which, as it so happens, is quite suited to the aims of Leftwing type parties that are in power these days.If this trend remains popular, that is where we could see Australia’s Govt deficits headed; well over 10% of GDP. I can hear the words being uttered now ” A wide range of reknowned economists are unanimous in recommending Govts go deeper into deficit to stimulate flagging economies”.
You assume that Govts might learn , I guess I don’t. I see a breakneck race to spend by our Govt ending in a complete disaster- THEN will come the end to spending, amidst the rubble of our society and economy.
http://www.businessspectator.com.au/bs.nsf/Article/Now-thats-an-economic-conservative-$pd20090310-PYQT9?OpenDocument&src=sph
“The Nobel laureate’s guiding principle for a government like Australia trying to grapple with the economic crisis is ‘Do no harm’, also the first rule of medicine.”
“The ‘do no harm’ principle flies in the face of the ‘doing something is better than doing nothing’ action-man posture of many Western governments. Becker worries that knee-jerk, almost random policies can easily make a bad economy worse.
Yet so many other economists find the notion of big-spending stimulus packages appealing”
“Becker notes that during World War II, the US was suffering unemployment of 17 per cent, not the 8 per cent of today. It’s easy to reduce unemployment, as they did, if you swiftly mobilise millions into the armed forces.”
I hope Kevin Rudd is reading this too.
MACCA
I refer to the peak household debt of 165% of GDP and the 700 billion$ of overseas debt racked up by this country while sucessive governments looked on and praised themeselves for fiscal frugalty.
I agree the government should not now take on this debt, but take it on they will. The disaster that you talk about is not avoidable.
I do not think that the governments will learn. They fuelled this problem for the last thirty years as the crisis developed very slowly. There is no chance that they will learn from what is happening now at a much greater rate.
Hey Elliotwave
What’s your view on silver, I get the feeling if there is mad rush to gold coins, which there is, then golds little brother silver, will be the next port of call for the average bear. 5000 years of history says silver is money and will hold its value. In fact I believe that the OT word for money is silver.
SteveZ points out that debt forgiveness is a slippery slope.
Steve – what is the economic incentive for banks to allow borrowers to become renters at mandated rates? Basically you are suggesting that banks should start carrying massive amounts of non-performing loan on their books, with very limited on going recovery and no ability to liquidate these assets. This would seem to have the effect of crippling the banks by drying up liquidity. Can you explain why this would not be the case in practice?
What is the disincentive that will stop people who can readily afford to pay their full rack mortgage from dropping back to paying “rent” to the banks? What’s to stop some fancy foot work by Joe Bloggs who transfers his non-home equity wealth to Jane Bloggs, quits his high stress, high paying job to “rent” his property back from the bank at a greatly reduced rate? I see SEVERE moral hazards with your suggestion.
IMO the excess leverage in the Australian resi-mortgage market was NOT driven by greedy mortgage sales people (as was the case in the US), it was caused by greedy homeowners who saw prices rocketing and wanted a piece of the action. I have heard of plenty of (foolish) people who bought investment properties to help them afford to buy a house (by taking the equity out as the investment increases in value), many people did this many times over running strings of properties. These people deserve to lose their equity. Being forced to sell their house and move to cheaper, less salubrious accommodation in an outer suburb is the penalty that prevents moral hazard and hopefully prevents these guys from being fools again. The bank deserves some pain for inadequately assessing the risk, but most of the pain goes to the greedy idiot who bought the house.
Yes, this will cause property prices to drop. This is not a bad thing, it is fair. There are plenty of cashed up people interested in buying at the right price… I have been ready to buy for a while now, but haven’t yet as prices have been super-inflated.
Steve,
Because the unemployment benefit equates to a paltry $5.00 per hour (less than 30% of the basic wage) I reckon that the government should, in this economic climate (or in any economic climate for that matter) offer people the choice of community work, road building or anything else that benefits all of us and pay a minimum of $7.00 per hour worked on top of the dole (awful word), tax free and with no effect on the base payment. This would give a family around $480.00 per week to live on (still a paltry sum but better than the alternative).
I also concur with your comments on waiting time for the unemployment benefit due to savings.
Six years ago I found myself unemployed and had to wait 7 weeks to get a payment because we had $10,000 in our account. If I hadn’t been lucky enough to get a job we would have been stuffed.
If I had taken the trouble to read the fine print before applying I would have withdrawn $5000 from the account and put it under the bed.
More spleen will be vented shortly.
Australia ranks about 15th in the world in terms of GDP size with about 1.67% of World GDP. Here is our Federal Treasurer gloating because this year we are the world’s third biggest borrower taking up 10% of all the debt in the world!!!!!!
Australia’s financial system is in “good shape” and banks will issue as much as 10% of global guaranteed debt this year, ranking Australia third in the world, Mr Swan said. Sydney Morning Herald
It brings to mind Mark twain’s quote
Sometimes I wonder whether the world is being run by smart people who are putting us on or by imbeciles who really mean it…Mark Twain