Debtwatch No 41, December 2009: 4 Years of Calling the GFC

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I first realised that the world faced a serious financial crisis in the very near future in December 2005, as I prepared an Expert Witness Report for the NSW Legal Aid Commission on the subject of predatory lending.

My brief was to talk about the impact of such contracts on third parties, since one ground to overturn a loan contract was that it had deleterious impacts on people who were not signatories to the contract itself. I was approached because the solicitor in the case had heard of my academic work on Hyman Minsky’s “Financial Instability Hypothesis”.

Minsky’s hypothesis argued that a capitalist economy with sophisticated financial institutions could fall into a Depression as an excessive buildup of private debt occurred over a number of financially-driven business cycles. I had built a mathematical model of Minsky’s hypothesis in my PhD, which generated outcomes like the one shown below: a series of booms and busts lead to debt levels ratcheting up over time, until at one point the debt-servicing costs overwhelmed the economy, leading to a Depression.

Figure 1

When I began writing my Report, I started with the comment that “debt to GDP levels have been rising exponentially”. But since I was an Expert Witness in this case rather than the Barrister, I knew that I couldn’t rely on hyperbole–and if the trend of growth wasn’t exponential, then I couldn’t call it that. I expected that there would be a rising trend, but that it wouldn’t be quite exponential, so I would need to amend my initial statement.

I downloaded the data on Australian private debt and nominal GDP levels from the RBA Statistical Bulletin, plotted one against the other, and my jaw hit the floor: the trend was clearly exponential. The correlation coefficient of the data since mid 1964 with a simple exponential function was a staggering 0.9903. The only thing that stopped the correlation from being absolutely perfect were two super-bubbles (on top of the overall exponential trend) in 1972-76 and 1985-94.

Figure 2

I expected that the situation in America would be as bad or worse, which was confirmed by a quick consultation of the Federal Reserve’s Flow of Funds data. Though not as obviously exponential as in Australia’s case, the correlation with simple compound growth was still 98.8%.

Figure 3

So debt had been growing faster than GDP–4.2% per annum faster in Australia’s case for over 40 years, and 2.7% faster for longer in the USA’s. An unsustainable trend in debt had been going on for almost half a century.

Staring at those graphs (at roughly 3am in Perth, Western Australia), I realised that these debt bubbles had to burst (and probably very soon), that a global financial crisis would erupt when they did, that someone had to raise the alarm, and that given my knowledge, that someone was me. As soon as my Expert Witness Report was finished, I started making comments in the media about the likelihood of a recession.

Less than 2 years later, the Global Financial Crisis erupted, and economists who didn’t see it coming, and who for decades had argued that government spending could only cause inflation, suddenly called for–and got–the biggest government stimulus packages in world history to prevent an economic Armageddon.

To some degree, the government stimulus packages worked.

I am happy to admit that the scale of the government countermeasures surprised me. As Australia’s Prime Minister Kevin Rudd pointed out, the collective stimulus over the 3 years from September 2007 till September 2010 was expected to be equivalent to 18 percent of global GDP. That was huge–bigger in real terms than the US’s military expenditure during World War II.

That huge government stimulus has attenuated the severity of the crisis, and led to positive growth figures in many countries–most notably Australia, which recorded only one quarter of falling GDP versus a norm of 4 consecutive quarters for most of the OECD. But it still has not addressed the cause of the crisis–the excessive level of private debt, and the transition from a period of decades in which rising debt fuelled aggregate demand, to one in which the private sector’s attempts to reduce debt will subtract from aggregate demand.

For that reason, I do not share the belief that the GFC is behind us: while the level of private debt remains as gargantuan as it is today, the global economy remains financially fragile, and a return to “growth as usual” is highly unlikely, since that growth will no longer be propelled by rising levels of private debt.

Private debt has, as in past downturns, started to fall compared to GDP–though in Australia’s case the so-called “First Home Owners Boost (which doubled the amount of money the government gave to first home buyers from A$7,000 to A$14,000)  enticed so many new entrants into mortgage debt that Australia’s ratio started to rise again in mid 2009.

America’s ratio, on the other hand, continued to rise through the start of the GFC, but is now clearly falling.

Figure 4

Having driven demand higher every year since the 1990s recession by rising and rising faster than nominal GDP, private debt is now falling and reducing aggregate demand. This is deleveraging at work, and it is the force that governments are trying to resist by boosting their own spending as private spending stagnates.

Figure 5

Australia’s success in avoiding a recession has been partly due to the fact that its policies encouraged private debt to grow again, as first home buyers took the additional A$7,000 of government money to the banks and borrowed against it (but even there, debt reduction by business and the reduction in personal debt is counteracting the rise in mortgage debt).

Figure 6

This is one foolproof means to avoid a serious recession–go back to borrowing and spending up big. This is, after all, what ended the recession of the 1990s–and in the USA’s case, it happened without debt actually falling. Australia’s greater recession then was due to the fact that debt did actually fall between 1991 and 1993, so that deleveraging drastically reduced aggregate demand.

Figure 7

So could the global economy get out of the global financial crisis the same way it got out of the 1990s recession–by borrowing its way up? That’s where the sheer level of debt becomes an issue–and it’s why I stuck my neck out and called the GFC, because I simply didn’t believe that we could borrow our way out of trouble once more. Debt did continue rising relative to GDP for several years after I called the GFC, but it has now reached levels that are simply unprecedented in human history.

For the “borrowing our way out” trick to work once more, we would need to reach levels of debt that would make today’s records look like a picnic. What are the odds that that could happen again?

Figure 8

The debt servicing burden

The simplest measure of the impact of debt levels on the economy is to look at the ratio of interest payments to GDP. There are obviously two factors here: the level of interest rates, and the ratio of debt to GDP. A very high rate of interest–such as applied during the 1970s–can mean that even a low level of debt (relative to income) is hard to service; conversely, a low rate of interest–such as we have now–can be hard to service if debt levels are very high.

The next two charts illustrate this for Australia and the USA by recording interest rates on the vertical axis and the debt to GDP ratio on the horizontal. The smooth curves on the charts show combinations of the debt to GDP ratio and the rate of interest that require the same proportion of GDP to be devoted to debt servicing. The jagged lines show the actual progress of the debt servicing burden over time in both countries–starting from 1959 in Australia’s case and 1971 in the USA’s (the earliest date for my data on US average interest rates). The diagrams tell an interesting story about the evolution of the Ponzi financial system we now inhabit.

Back in 1960, debt servicing in Australia required a mere 2% of GDP. This rose rapidly to a peak of 16.7% of GDP in 1990–the beginning of Australia’s most severe post-War recession–as both interest rates and the debt to GDP ratio rose.

Then the servicing costs plummeted dramatically in the aftermath to the 1990s recession, as the Reserve Bank drastically cut rates–in the belated realisation that they had set them far too high in the late 80s in an attempt to control the asset bubble of that decade–and as the debt to GDP ratio fell (as did the actual debt level) during the recession.

Then Australia bounced along an 8% debt burden contour between 1993 and 2000, as interest rates fell while debt levels–driven by rising mortgage debt–rose.

Next the burden began to rise from 2003, as mortgage and business debt both expanded and the RBA began increasing rates to attempt to control the booming economy.

Rates then reached their peak in mid-2008 when the RBA finally realised that, rather than inflation being the main danger facing the economy, we were actually in a financial crisis. At this point, the debt servicing burden on the economy was the same as it was in 1990–even though rates were half what they were then–because the private debt to GDP ratio had doubled in the meantime.

The RBA went rapidly into reverse–cutting rates at 1% a month after having previously increased them in 1/4% steps. The debt  ratio started to fall, and the debt servicing burden fell back to 10.25% of GDP–from where it is now rising once more as First Home Buyers pile on more debt, and the RBA is back once again fighting the mythical dragon of consumer price inflation (though recent comments imply it is also finally targetting house price inflation too).

Figure 9

The American story is similar, but involves much larger levels of debt and a consequently higher debt servicing burden. This began at over 5% of GDP in 1971, and rose to a massive 23.4% of GDP in 1981–a different date to Australia’s, but also the time of the USA’s worst post-War recession (this is not a coincidence). Average interest rates peaked at 19.75% under Volcker in mid 1981.

The burden then fell rapidly as rates were cut significantly, only to rise once more as the 1980s stock market bubble took off, and the Volcker Fed tried to restrain the bubble once more with rising rates.

Then the 1987 crash hit, followed by the 1990s recession, and under Greenspan rates were pared back as the debt to GDP ratio actually fell for a time.

Then the DotCom bubble began, and debt began to rise once more–and the Subprime bubble commenced in the background. The Fed responded to the DotCom bust of 2000 with a rapid cut in its rate that drove average rates down from around 9% to just 4.4%, while at the same time rising mortgage and financial sector debt pushed the aggregate debt ratio past the Great Depression record of 235% of GDP.

Figure 10

The Fed, firstly under Greenspan and then Bernanke, tried to restrain the bubble with rising interest rates once more–until the Subprime Catastrophe hit and it once again went into reverse, driving its own rate down to zero and the average rate to about 3.5%. That is where the USA now wallows, with a debt burden of almost 300% and a debt servicing burden of 10% of GDP.

Both countries now have lower average interest rates than they had back in the 1960s, but a debt servicing burden that is many times higher (five times higher in Australia’s case and double in America’s) because both Central Banks obsessed about the rate of consumer price inflation, while ignoring rampant growth in private debt.

And it’s actually worse than that when one considers the longer term.

Deflation and Depressions

There are actually two ways to reduce your debt burden–by paying it down yourself, or by letting inflation do it for you. So to gauge the real impact of debt on an economy, you have to consider the after-inflation rate of interest–and when inflation is high, this can actually be negative.

Conversely, when deflation strikes, the real rate can be higher–much higher–than the nominal rate. This is why Fisher called his theory “the Debt-Deflation Theory of Great Depression”–because debt on its own was nowhere near as dangerous as deflation. Considering the real debt servicing burden emphasises how much danger we are in now. The two big Depressions of the last one and a half centuries–the 1890s and the 1930s–had substantial deflation–with prices falling at up to 15 percent per annum in the 1890s, and over 10 percent per annum for two years during the Great Depression. That meant that even a low nominal rate of interest was a huge real rate.

Figure 11

Figure 12

Conversely, periods of high inflation in the post-WWII period have meant that even high nominal rates meant low–and in some cases negative–real interest rates (it was cheaper to borrow money now and pay it back later than it was to avoid debt).

The effect of inflation drastically transforms the interest payment burden map–and it emphasises the dangers in the low inflation environment we are now in.

For Australia, the worst real burden of debt servicing occurred in the 1890s, when our debt to GDP ratio was higher than in the 1930s, and deflation drove the real rate of interest to over 20 percent. At that point, 19% of Australia’s GDP was needed to service debt–and the economy fell into a deep Depression (worse than the Great Depression) as a result.

Figure 13

Figure 14

I don’t have data on 1890s debt levels in the USA, but I doubt that it could compare the the Great Depression in that country, as the real debt repayment map below emphasises. The combination of–until then–an unprecedented level of private debt and steep deflation meant that the real debt burden on the economy consumed 50% of GDP (using Moody’a Baa rate as a proxy for the average interest rate).

Figure 15

Figure 16

All of the above points out how dangerous a situation we are in with inflation rates as low as they have been driven by globalisation and by Central Banks that have obsessed about the rate of consumer price inflation and ignored both asset price inflation and the debt levels that have driven it.

In Australia’s case, all it would take is a 6% change in the real interest rate to put us back in the same situation we were in during the 1890s–because debt today is about 65% higher than back then.

In America’s case, a much larger jump of 11.5% is required to bring it back to the 1930s situation–but that’s before we take into account the impact of deflation on the debt ratio itself, since deflation actually increases the real debt burden as well as increasing real interest rates. That effect was drastic during the Great Depression: the US’s debt ratio rose from 175% to 235% even as debt fell from $162 billion to $125 billion.

Figure 17

If a similar effect applied this time and deflation drove private debt levels to 400% of GDP, it would only take a 6% rate of deflation to put America in the same position it was in in 1932.

I hope this review establishes why the debt to GDP ratio is such an important indicator of financial fragility, and why as a consequence the GFC is far from over.

Only one question remains: why do Central Banks ignore the debt to GDP ratio?

There is nothing more dangerous than a bad theory

The simple reason is: because they are neoclassical economists. You don’t get to be a Central Banker without a degree in economics, and the school of thought that dominates economics today is known as neoclassical economics. Though a lot of what it says appears to be superficially intelligent, almost all of it is intellectual drivel, as I outlined in my book Debunking Economics (which summarised a century of profound critiques of this theory which its practitioners have studiously ignored).

Since critiques by economists and mathematicians of this theory have literally filled books, I won’t try to go into all of them here. Just three key neoclassical myths suffice to explain why they do not understand the dynamics of our credit driven society. They believe that:

(1) The nominal money supply doesn’t affect real economic output;

(2) The private sector is rational while the government sector is not; and

(3) That they can model the economy as if it is in equilibrium.

The first myth means that they ignore money and debt in their mathematical models: most neoclassical models are in “real” terms and completely omit both money and debt. So since debt doesn’t even turn up in their models, they are unaware of its influence (even though their statistical units do a very good job of recording the actual level of debt).

The second myth means that they are quite willing to obsess about government debt, but they implicitly believe that private debt has been incurred for sensible reasons so that it can’t cause any problems.

The third myth means that they ignore evidence that indicates that the economy is very far removed from equilibrium, and they misunderstand the effect of crucial variables in the disequilibrium environment in which we actually live.

I can give two instances of how this has affected attempts to get Central Bankers to realise that the debt to GDP ratio matters: Ben Bernanke’s discussion of Irving Fisher’s “Debt Deflation Theory of Great Depressions”, and a discussion I had with a Assistant Governor of Australia’s Reserve Bank on the topic.

Bernanke an expert on the Great Depression?

Ben Bernanke got his current position largely on the basis of his reputation as an expert on the Great Depression. In his Essays on the Great Depression, he explained why most economists ignored Irving Fisher’s theory of how the Depression occurred–which emphasised the importance of debt and deflation:

“The idea of debt-deflation goes back to Irving Fisher (1933). Fisher envisioned a dynamic process in which falling asset and commodity prices created pressure on nominal debtors, forcing them into distress sales of assets, which in turn led to further price declines and financial difficulties. His diagnosis led him to urge President Roosevelt to subordinate exchange-rate considerations to the need for reflation, advice that (ultimately) FDR followed. Fisher’s idea was less influential in academic circles, though, because of the counterargument that debt-deflation represented no more than a redistribution from one group (debtors) to another (creditors). Absent implausibly large differences in marginal spending propensities among the groups, it was suggested, pure redistributions should have no significant macroeconomic effects.” (Bernanke, 1995 p. 17).[1]

Though Bernanke notes that Fisher “envisioned a dynamic process”, his statement of why neoclassical economists ignored his theory is inherently couched in equilibrium terms–it sees debt-deflation as merely redistributing income from one group in society (debtors) to another (creditors).  How can aggregate demand fall so much, if all that is happening is a transfer of income and wealth from one group of consumers to another?

However when one thinks in truly dynamic terms, income is not all there is to aggregate demand. In a dynamic setting, aggregate demand is not merely equal to income, but to income plus the change in debt.

During a debt-driven financial bubble–which is the obvious precursor to a debt-deflation–rising levels of debt propel aggregate demand well above what it would otherwise be, leading to a boom in both the real economy and asset markets. But this process also adds to the debt burden on the economy, especially when the debt is used to finance speculation on asset prices rather than to expand production–since this increases the debt burden without adding to productive capacity.

When debt levels rise too high, the process that Fisher described kicks in and economic actors go from willingly expanding their debt levels to actively trying to reduce them. The change in debt then becomes negative, subtracting from aggregate demand–and the boom turns into a bust.

Debt has little impact on demand when the debt to GDP ratio is low–such as in Australia in the 1960s, or the USA from the start of WWII till the early 60s. But whenever the debt to GDP ratio becomes substantial, changes in debt come to dominate economic performance, as can be seen in the next two charts.

Figure 18

Figure 19

It is this effect that eluded Bernanke and his neoclassical brethren, because of their insistence on trying to model the world as if it is always in equilibrium. The debt-driven demand process is obvious when you think dynamically, but if you try to put it into an equilibrium straightjacket–as neoclassical economists did–then you can’t understand it at all.

A “schoolboy error”?

In 2008 I spoke at a seminar in Adelaide that was also addressed by Guy Debelle, an Assistant Governor (Financial Markets) of the RBA. After my talk he commented that he couldn’t understand why I compared debt to GDP, since that was comparing a stock to a flow.

I was rather nonplussed by the question–to me, the reasons why it matters are obvious–but I attempted an answer and thought little more about the incident.

Some time later, Debelle’s ex-colleague and good friend Rory Robertson of Macquarie Bank repeated Debelle’s observations in his interest rate newsletter, parts of which were then republished on a number of business blogs, including Business Spectator. Amongst other things, Rory remarked that:

Dr Steve Keen amongst others continues to make the schoolboy error of comparing debt to income (a stock to a flow – apples to oranges) and misses the main game. (Rory Robertson)

The proposition that comparing debt to GDP is making a stock/flow error may appear wise at first glance, but it is in fact nonsense. It instead shows that the person making the comment does not understand dynamics–which is a failing shared by almost all neoclassical economists.

In dynamic terms, the ratio of debt to GDP tells you how many years it would take to reduce debt to zero if all income was devoted to debt repayment. That is an extremely valid indicator of the degree of financial stress a society (or an individual) is under.

I find that members of the general public understand this easily. Only economists seem to have any trouble comprehending it–not because it is difficult but because their own training pays almost no attention to dynamic analysis, and therefore they don’t learn–as systems engineers do–that stock/flow comparisons can be extremely important indicators of the state of a system.

Marching ignorantly forward

With such ignorance about the dynamics of debt, academic economists and Central Banks around the world are hoping that the crisis is behind them, even though the cause of it–excessive levels of private debt–has not been addressed. They are recommending winding back the government stimulus packages in the belief that the economy can now return to normal after the disturbance of the GFC.

In fact “normal” for the last half century has been an unsustainable growth in debt, which has finally reached an apogee from which it will fall. As it falls–by an unwillingness to lend by bankers and to borrow by businesses and households, by deliberate debt reductions, by default and bankruptcy–aggregate demand will be reduced well below aggregate supply. The economy will therefore falter–and only regular government stimuli will revive it.

This however will be a Zombie Capitalism: the private sector’s reductions in debt will counter the public sector’s attempts to stimulate the economy via debt-financed spending. Growth, if it occurs, will not be sufficiently high to prevent growing unemployment, and growth is likely to evaporate as soon as stimulus packages are removed.

The only sensible course is to reduce the debt levels. As Michael Hudson argues, a simple dynamic is now being played out: debts that cannot be repaid, won’t be repaid. The only thing we have to do is work out how that should occur.

Since the lending was irresponsibly extended by the financial sector to support Ponzi Schemes in shares and real estate, it is the lenders rather than the borrowers who should feel the pain–which is the exact opposite of the bailout mentality that dominates governments around the world.

Unfortunately, it will take a sustained period of failures by conventional policy before unconventional policies, like deliberate debt reduction, will gain political traction. Implementing them will require both a dramatic change of mindset and probably also a widespread changing of the political guard.

It will also require the breaking of the hegemony of neoclassical economics over economic thinking, but I doubt that the academic profession, or economists in Central Banks and Treasuries, are up to the task of changing their spots. Change in economics will have to come from the rebels, and from outsiders taking over a discipline that economists themselves have failed.

The second decade of the 21st century promises to be a dramatic one, politically and economically.

[1] Bernanke went on to develop his own interpretation of Fisher which I won’t bother with here because I don’t think it’s worth the effort.
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418 Responses to Debtwatch No 41, December 2009: 4 Years of Calling the GFC

  1. The Outback Oracle says:


    Westpac have put up their lending rate but have not put up their deposit rate. They do have a 6.2% rate going on 12 month money at the moment. They have a couple of ‘teaser’ rates for NEW accounts. Westpac certainly had something of a crisis during the GFC when they could not roll over their overseas money. So I am guessing that somewhere in the next few months there is a hump in their loan roll-overs that they need to cover.
    I am currently in a pitched battle with Westpac on this point. like many businesses mine is seasonal. They want to charge 9 or 10% on money we owe them and give us 3.45% on money we have deposited. Mostly we are caught with the problem of having loans and deposits at the same time for various structural and financial reasons.
    Anyway my main point is that Westpac have NOT increased deposit rates in any meaningful way.

    Kelly talks one thing and does another. She talks about needing more savings etc but then screws the savers to death at every opportunity.

  2. gaday says:

    Outback- Thanks for the explanation What you say makes sense.

  3. The USD Is Back says:

    Professor Keen, You have a fantastic website. Keep up the great work.

    To the goldbugs on this site. A MASSIVE USD REVERSAL is currently underway, both from a fundamental and tech analysis point of view.

    Let’s face it, if a USD recovery occurs (ha,ha!) then the USD goes up.

    If a sharemarket panic occurs, then the USD will go up.

    If deflation occurs, the USD will go up.

    When the currently short USD traders go long, the USD will up.

    Your Aussie economy is overstimulated, overleveraged and ripe for a massive correction similar to what has already occured in the world. Your Aussie dollar has already started to go down.

    You can’t bet against America, the greatest country in the world.

    Sell Gold.


  4. ak says:

    I would like to recommend the book already mentioned by scepticus, I managed to read it yesterday:

    It puts our current global situation in the right perspective. It is such a shame that people living in Australia, USA, UK (and Poland as well) can talk hours about lives of so-called celebrities but have no idea what happened in the 17th, 18th or 19th centuries. Not only mathematics is neglected at school or university but also history. What is going to happen soon will most likely hardly differ from the past events because the mechanism is the same – only the scale and external form is different. There is no “new paradigm” – because there cannot be.

    “Spain’s defaults establish a record that remains as yet unbroken. Spain managed to default seven times in the nineteenth century alone, after having defaulted six times in the preceding three centuries. With its later string of nineteenth-century defaults, Spain took the mantle for most defaults from France, which had abrogated its debt obligations on nine occasions between 1500 and 1800. Because the French monarchs had a habit of executing major domestic creditors during external debt default episodes (an early form of “debt restructuring”), the population came to refer to these episodes as “bloodletting.” The French Finance Minister Abbe Terray, who served from 1768–1774, even opined that governments should default at least once every 100 years in order to restore equilibrium”

    “If serial default is the norm for a country passing through the emerging market state of development, then the tendency to lapse into periods of high and extremely high inflation is an even more striking common denominator. No emerging market country in history, including the United States has managed to escape bouts of high inflation.”

    “Some writers seem to believe that inflation only really became a problem with the advent of paper currency in the 1800s. Students of the history of metal currency, however, will know that governments found ways to engineer inflation long before that.”

    “The March Toward Fiat Money” shows that modern inflation is not as different as some might believe. However spectacular some of the coinage debasements reported (…), there is no question that the advent of the printing press cranked inflation up to a whole new level.”

    The author of the book, Kenneth S. Rogoff is hardly a heterodox economist, having served as Director of Research Department of the International Monetary Fund.

    This book should prove to some members of this forum advocating deflation and forcing the borrowers to pay the debt at any price that debt which cannot be paid, will not be paid. Either borrowers will go bankrupt wrecking the whole economic system or the debt will be inflated, reducing the real value of savings as well. There are no examples in history that the actual “cleansing” of the system by severe deflation and defaults actually worked. A default would only cause more defaults and human misery.

    The book also clearly documents how the global system evolved away from the gold money and gold standard. In my opinion only when we understand the past and current processes we can start making any predictions about the future or proposing new ideas how to attempt to fix the system.

  5. the_pro says:


    Do you believe that Judgement Day for the Australian property market will still occur in 2010 or have you revised your predictions because of the First Home Buyers Grant?

  6. burrah says:

    Bunning Bashes Bernanke
    Senator Bunning (R) Kentucky grills Federal Reserve Chairman Ben Bernanke over his unconscionable corporate socialism.

  7. scepticus says:

    AK, please also find time to read the gorton paper on the shadow banking system. Not only is it a revelation about the title issue, it is also a revelation about the social function of banking generally.

    its even better than the rogoff book.

  8. Steve Keen says:

    Yes, and it’s all the more likely with the First Home Vendors Grant coming to a close and the RBA being on the rampage against inflation with interest rate hikes.

  9. Philip says:

    Given how high prices are in Australia, I wonder if there will be enough political and economic pressure on Rudd to continue the FHOG after 1st Jan 2010. If that is the case, then it is likely the bubble will continue inflating. Otherwise, it will probably mean the beginning of the bubble bursting.

    Unfortunately, the higher the prices, the greater the pressure to continue the FHOG, which in the end simply pushes up prices. Thus the circle continues.

  10. debtjunkies says:


    Here is the link to the HIA pci for November.

    The report basically notes that the construction industry contracted in November. The only sub-sector that expanded was home construction.

    Given Rudds predication to want to be known as a builder of things (cars/houses/schools) IMO Im sure that in 2010 you will get an extension of the FHVG except that it must be used to build a new home. If the pressure is enough Im sure he will also extend a grant to anyone who is building or buying a new house – similar to the grants extended to any buyer of a new home in NSW.

    It is the type of policy where they probably feel as if they can get the greatest bang for buck, help FHO, save construction industry, do something about rental shortfalls and it provides lots of good pictures in hard hats for the MSM.

    Houses are basically considered a sacrosanct part of “aussie life” and despite views to the contrary, IMHO it is probably the one form a further stimulus that the electrate will accept especially if it is sold as a measure to assist those in greatest need.

  11. creditdefaultswap says:

    Steve, thanks for this post and your previous help. As you add public debt to your analysis, you may consider “opaque” debt, such as the US social security and medicare spending programs.
    We can see the US public debt growth replacing consumer debt growth as the US increased transfer payments such as social security, unemployment benefits, food stamps, etc and decreased taxes in the last fiscal year. In addition the US increased GDP by increasing Medicare/hospital spending by 100 Billion dollars.
    Another point, I find that I cannot treat household debt in the US the same as either business or financial debt. The spread of Enron accounting in the US has made this classical economic assumption invalid. The higher rate of increase in financial debt is one indicator of that.
    President Hoenig of the Kansas City FRB may have read your works as he did plot debt versus time in his August speech.
    I have a small problem with him mislabeling flow of funds table L10 personal sector debt as “consumer” debt. This adds roughly 5.8 Trillion of “non corporate business” debt to 13.7 Trillion of household debt.
    An extrapolation of the stress indicator is the current ratio of US household debt, 13.7 Trillion to US wage income of roughly 6.5 Trillion,( after deducting social insurance taxes).

  12. Vfe says:

    Philip and others re the extension of the boost/grant, you have to wonder whether it will have as great an impact. The recent boost brought forward massive levels of demand and you’d have to expect a black hole behind it. What’s more, with continued growth in prices the pressure on loan serviceability would be huge, especially in an environment of stagnant income growth.

    Towards the end of the Boost we saw the bottom of the barrell being scraped. Dual income couples were qualifying for loans by declaring their purchase as an investment (i.e. use the forecast rental income to get them over the line), only to ‘change their minds’ at settlement and become owner occupiers. Perhaps this is the purpose of this 10,000 person per week migration program – demand import?

  13. ak says:


    Migration of people who have a significant amount of money has been reduced.

    “The new Chinese ascendancy owes more to a collapse in migration from the traditional sources than it does to the 15 per cent annual growth in migration from China. The number of migrants from Britain is down 28 per cent over the year and the number from New Zealand is down 47 per cent.”

    “In March the Government sliced 18,500 off the skilled migration program for 2009-10, disproportionately hitting Britain for which skilled migrants account for eight out of 10 flights booked. Chinese migration, dominated by family reunions, suffered less.”

  14. homes4aussies says:

    I’m in the no extension to the First Home Vendor’s Boost camp. Because I essentially agree with Vfe above, and they would not want to give up the illusion of it’s omnipotence (seeing as probably the greatest propaganda tool spruikers have is that Government is all powerful and will do what it needs to prevent house prices from falling).

    I would suggest that the most likely next cab off the rank is the naive first time investor.

    I would like to think – if they did introduce further stimulus – it would be aimed solely at new housing (even though I think it is entirely possible that we actually have no shortage of housing). But this would have less effect on prices than also targetting existing housing – thus it would not meet their real aim of perpetuating the bubble.

    Contrary to many, I think the political will to perpetuate the bubble is far from infinite – especially when linked to Government debt and our kids’ futures (the opposition strategy, when it’s not committing hari kari).

    However, as stated many times here, I think that the bag of tricks will run out of power before that point is reached in any case because market psychology will turn, and the uncertainty of capital growth will lead people to make more rational decisions on value. On this point, it’s interesting the discussion (not sure if it was here or elsewhere) about investors being “priced out” by the boosters – of course that is ridiculous – they are simply applying a more stringent assessment on value than what they were earlier in the bubble.

    And, although we don’t have published hard figures, there is much evidence that the investor dominant markets are really suffering. Recently Louis Christopher mentioned that the hotspots for old listings (properties that have been on the market for 2 months or more) were the Gold Coast and Sunshine Coast. And the below report by Fitch on mortgage stress (released today) shows that the highest level of mortgage stress in the country is in the holiday area Nelson bay because “They’re just not being able to sell the properties” when they get into arrears.

    So even if they do want to stimulate the investor market, and even if the political will exists (ie. electoral support), and even if the investors respond – there seems to be a significant amount of stock to be soaked up before there would be an upward effect on price.

    And I can’t forget about the 4Corners program on James Packer where the “Vulture of Vegas” showed Michael Barry the apartment one below the penthouse with an “in your face” view of the strip currently on the market for US$399K and negotiable (sold new two years earlier for over double that). In the next stage apartment tower, brand new apartments with an even better view of the strip, only around 30 out of 360 have been sold!

    If property investing was your game, why invest in the last remaining bubble? With the $ approaching parity I reckon a flash Las Vegas apartment for $400K would beat a small apartment with a nice view of the “black stump” for the same price.

    Perhaps that’s why they target the naive…. 😉

  15. homes4aussies says:

    Just reading the FitchRatings report (go to subscribe and search “postcode” to view the report).

    One very interesting point. Even though the graph of 30+, 60+ and 90+ day delinquency clearly shows a down trend from 2009Q1 – as expected – at 30 Sep 2009 the 90+ day delinquency line has only just reached the level it was at around June/July 2008 (when mortgage rates were 3-4% higher) which also corresponds with the early 2007 peak in the the first upcycle shown in the graph (data from 2003 to 30 Sep 2009).

    No doubt our delinquency rates are low by international standards.

    But the fact that the lowest cash rate in half a century – and unprecedented cash handouts – did not bring the 90+ day delinquency rate much lower is very telling in my view!

  16. Eternal Student says:


    For those of you who really don’t need Yet Another Internet Account, works quite well for this site.

  17. angophera says:


    “I wonder if there will be enough political and economic pressure on Rudd to continue the FHOG after 1st Jan 2010. If that is the case, then it is likely the bubble will continue inflating.”

    The housing bubble could be popped by a few different factors eg. increasing unemployment.

    Extending the FHOG might kick the can down the road but it might only delay the inevitable. It depends on how much impact the FHOG had on the time preference of consumers of housing. If it has pulled future demand into the present a void could open up on the demand side of the market later regardless of incentives.

    Another big factor is demographics. How many baby boomers are planning to downsize their home as part of their retirement plans? As increasing numbers of boomers “head for the exits” supply could also outstrip demand on a geographic basis eg. plenty of stock in the wrong place.

    Alternatively this could manifest as a mismatch between the housing stock on offer (4 Bedroom McMansions) and, say, a demand from the market for smaller, low cost housing.

    Peak Cheap Oil (if not Peak Oil) could slash the price of housing stock on the urban fringes that are car dependant and/or lack cheap public transport options.

    I recently listened to an interview on ABC Radio National. A spokesman for a group concerned about the population carrying potential of Australia made the point that a 2% growth rate gives a doubling time of 36 years. We are currently around 22 million.

    Double the roads, hospitals, sewerage works, potable water and so on? I think not. To underline the problem our banks raise around 50% of the funds they re-lend by borrowing from foreign investors according to David Murray*. A lot of this debt was Uridashi** debt placed in Japan. How is Japan looking at the moment? Can we support this “doubling” on borrowed money? Again, I think not.

    *Chairman of the Future Fund and former MD of the Commonwealth Bank.
    ** I can’t bring myself to say Uridashi “bonds”, Uridashi IS the Japanese word for bond.

  18. homes4aussies says:

    Another story on Nelson Bay from today’s SMH –

    I can also recall recent similar stories about Mundarah (?) in WA – which a year or two back was in the headlines for having the most expensive homes relative to wages in Australia.

    This is widespread, I am certain.

    Ready for the First Home Investor Boost??? I used to think there would be a 10th home investor boost – but I think they’re already tapped out like the kids – and the banks seem to be more cautious on them – so that just leaves the ones that have largely resisted to this point the temptation of “equity” withdrawal to “invest” or waste on rampant consumerism.

    How many of those are around – and how many are naive enough to take the bait???

    Not many would be my guess. I really do think there has been an exhaustion of greater fools. What a shame a lot of those fools were just inexperienced kids enticed by a couple of extra $K from Rudd….

  19. angophera says:

    The USD Is Back,

    If you are in the mood to buy USD try China and Japan. I understand they have a few they may be prepared to part with.

    Incidentally among us tinfoil hat wearing, counterparty mistrusting, gold bugs there is a scenario doing the rounds that, in part, goes like this:

    1. For the first time in 30+ years of trying to get an audit or “end the Fed” bill up Congressman Ron Paul “miraculously” gets support in 2009.

    2. If the audit is allowed to proceed it discloses that the privately owned Fed is “shock! horror!” insolvent.

    3. The USD = Federal Reserve Note (FRN). Congress members place hands solemnly over their hearts and announce that an insolvent bank cannot issue the currency of a proud and sovereign nation.

    4. Congress rediscovers part of the Constitution as legal cover for cancelling the FRN and having Treasury issue the New Dollar. Conversion rate is high enough to rebalance the Federal finances, say, minimum 3:1 old for new.

    5. Treasury debt gets dealt with in parallel. A default I hear you cry, impossible. Entirely possible for a country that has done it twice before in the recent past (Roosevelt in the 1930s and Nixon in the 1970s) and more than once in the distant past.

    6. All aggrieved parties weigh up advisability of going to war with the most powerful military machine on the planet. Parties decide to grin and bear it.

    7. Joe Sixpack and fellow USA citizens wake up to find that they have been screwed royally. So, what else is new?

    Observe the recent news out of North Korea. Their new-for-old deal, I think was around 100 old for 1 new.

    Also please take note of Argentina’s post-coralitos devaluation of around 75% in the early part of this decade.

    Zimbabwe also made the news when it withdrew the Zim dollar and produced a 100% loss for debt denominated in their paper. Incidentally this stopped hyperinflation virtually overnight. Nowadays other currencies circulate freely as money in Zimbabwe and the contry is recovering. Please see the link below:
    Zimbabwe – A Fresh Start
    by Alf Fields

  20. Vfe says:


    That Nelson Bay data is a significant local adjustment in anyone’s terms. confirms plenty of discounting going on. I’m not familiar with the area, I suspect highly speculative coastal holiday town?

  21. ajtj99 says:

    I don’t know if anyone’s seen it before, but I thought this white paper from Carmen M. Reinhart and Kenneth S. Rogoff published April 8, 2008 seems relevant to the discussion:

    It discusses sovereign defaults throughout the past 800-years and how they seem to happen in cycles.

    I think this is significant in that during the peak of the last cycle of defaults after the Great Depression, the ratio of sovereign defaults hit 40% of global GDP. With major economies such as Japan, Great Britain, and the United States all looking at possible default in the next 10-years, I thought it was relevant to this forum.

    Prior to the US Great Depression, debt to GDP levels hit about 150% at the peak in 1929. From there we saw the rate of debt to GDP drop to around 50% in the 1950’s.

    With the advent of consumer debt like credit cards and consumer asset backed loans, the ratio will likely never drop to the post-war lows. However, it would be reasonable to assume a drop of 100% of GDP peak to trough in the private de-leveraging cycle were it allowed to run its course. While that would only take the US down to a debt to GDP ratio of around 250% of GDP, it would mimic the post-Depression cycle drop of 100% of GDP.

    However, if the debt keeps expanding after the start of the financial crisis like it has, we will likely need to lose the 100% of GDP in debt through a sovereign debt default.

    I really don’t see any workable real-world alternatives.

  22. Pingback: Wither Economics? « David Ramsey’s Weblog

  23. Pingback: 4 Years of Calling the GFC |

  24. Andre says:

    Steve, this is my first post. Could I please start by blowing my own trumpet? I called the GFC at about the same time as yourself, and I am not a professor of economics. In fact I have never done a course in economics in my life, which was perhaps beneficial in this respect. My assessment was based on common sense (which seems to be in short supply in the economics profession):

    1. Too much euphoria: Stocks and house prices on a never-ending trajectory upwards.
    2. Come to think of it now, there was only a point 1.

    And my simple-minded assessment is that this arises from a number of causes, which are mostly to some degree interrelated, and mostly stemming ultimately from the first point:

    1. Failure of the democratic form of government. Politicians have to be willing to give the majority of voters what they want, and most want something for nothing.
    2. Reward for debt and punishment of saving (exactly the opposite of what I was taught as a kid).
    3. Out of control remuneration in the financial industry. This attracts talented people into a career of money shuffling, rather than useful productivity in society.
    4. Financial “success” for the individual is as much, if not more, a function of “investment” ( or “speculation”?) rather than productive effort.
    5. Lack of transparency in many areas of society (finance, government, business). You can’t make sensible decisions if you don’t know what is going on.
    6. Control of the news media by a small elitist class (though I admit the advent of the internet is reducing their influence somewhat).
    7. Dumbing down of the general intellect of society by the endless and mindless flow of professional sports “entertainment”. This little trick has been known since the time of the ancient Romans.
    8. The woeful state of Economics as an intellectual pursuit, which is obvious to me from reading your blog and the thoughts of “Austrian” economists, whose writings I admit I find somewhat attractive. It is distressing that such an important subject is languishing in such a sorry state. It sounds like a pleasant past time for armchair intellectuals and sure is still the “dismal science”.

    You say that “Since the lending was irresponsibly extended by the financial sector to support Ponzi Schemes in shares and real estate, it is the lenders rather than the borrowers who should feel the pain–which is the exact opposite of the bailout mentality that dominates governments around the world”. While I agree that lenders should feel pain, why not borrowers too? Both made mistakes and both should feel the pain of their errors. I’ll have none of this “there, there, you mucked up, but it’s ok, we are from the government and we are here to help” type of stuff. But then, of course, there are lots of borrowers and borrowers are voters and voters don’t like to feel pain, do they?

  25. Steve Keen says:

    I agree Andre–the remarkable thing wasn’t that I saw it coming but that so many economists didn’t. The signs were obvious as you say, and it takes a special set of delusions not to be aware of them.

    On borrowers, how many of them do you know who pay themselves million-dollar salaries on the basis of their financial expertise and brilliance? The power and research-capability imbalance between most borrowers and banks is so great that the latter deserve to feel 99% of the pain for this catastrophe.

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