It’s Debt, Debt, Debt for Australia!

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Last weekend’s Sunday Telegraph pointed out a new record for Australia: our ratio of household debt to GDP is now higher than the USA’s. I’ve written the following commentary on this dubious “gold medal” (or is it really lead?) for the ABC’s The Drum.

In all the self-congratulations over how Australia has managed to sidestep the GFC, an inconvenient truth has been overlooked: the crisis was caused by too much debt, and Australian households have had a stronger and longer love affair with debt than even the Americans.

As of the latest RBA figures, Australian households now owe the equivalent of an entire year’s GDP—3% more than Americans ever owed. We grew our debt pile much faster than Americans did. We are continuing to go deeper into debt, while American households have started to reduce theirs. And in one of the great travesties of our GFC sidestep, the most recent growth in household debt has been deliberately engineered by government policy.

Back in 1990, American households had twice our level of household debt—60% of GDP versus 30%. But after just 15 years, Australians had caught up: by 2005, both countries had household debt to GDP ratios of 86%. Just as the media started to focus on the Subprime Catastrophe in the USA, American household debt began to stabilise, while ours continued to grow—peaking at 99% of GDP in March of 2008, versus the USA’s all-time high of just under 97% one year later.

We actually began to reduce our debt levels before America—with household debt falling from 99% to 96% of GDP in March 2009. but then the federal government’s First Home Owners’ Boost began to kick in (it was introduced in October 2008, and I railed against it at the time—see “Rescuing the Economy or the Bubble?”). This enticed new entrants into mortgage debt in record numbers: during the life of the Boost, over 1 percent of the Australian population took the government’s additional $7,000 bribe down to the bank, and levered it up five or more times with a mortgage. Even though households were reducing other forms of debt, total household debt rose until it cracked the mark of 100% of GDP in the last month.

The good news—for the rest of us—from this First Home Buyers debt binge was that their borrowing was one of three domestic contributors to Australia avoiding a technical recession in 2009 (China’s own stimulus package was an important fourth factor). The additional $40 billion of mortgage-backed money combined with the $30 billion impact of Rudd’s stimulus packages, and the close to $40 billion boost from the RBA’s rate cuts, to dramatically increase both household incomes and spending. Gerard Minack from Morgan Stanley, who estimated that the last two factors increased household disposable incomes by 9% last year, commented that “If that’s a recession, bring it on!”

The bad news is that spending boost from additional mortgage debt is, in the immortal words of Paul Keating, a souffle that is unlikely to rise twice. There just aren’t that many more First Home Buyers who can be enticed into the market in 2010, even if the Federal Government follows NSW’s lead and extends its Boost for another six months. Property spruikers may be confident that the Great Australian House Price Bubble is back, but the market is unlikely to fly in the absence of deliberate government manipulation of demand and a renewed reluctance by buyers to go into debt.

That’s not to say that the banks and the property lobby aren’t doing their best to keep the bubble flying. Thanks to Kris Sayce from Money Morning magazine for bringing the following to my attention some months back: many lenders are now offering loans of 110% of the value of a property, so long as there’s a guarantor. Needless to say, the following excerpt from Home Loan Experts is not a product endorsement:

Guarantor home loan

Guarantor loans are now the only way to borrow 100% of the purchase price as no deposit home loans have been withdrawn from the market. Did you know that there are stark differences between the guarantor supported loans offered by different lenders?

With the help of a guarantor you can borrow over 100% of the purchase price which will allow you to buy a home and consolidate debts or renovate the property at the same time.
How much can you borrow?
  • First home buyer guarantor loan: 110% of the property value.
  • Second home buyer guarantor loan: 110% of the property value.
  • Refinance guarantor loan: 100% of the property value.
  • Debt consolidation & purchase guarantor loan: 110% of the property value.
  • Investor guarantor loan: 105% of the property value.
  • Construction guarantor loan: 100% of the property value & cost of construction.
  • Low doc guarantor loan: Not available with a guarantor mortgage. See below for our 80/20 method of financing low doc loans with the help of a family member…

Shades of Japan’s “99 year mortgages” at the height of their Bubble Economy back in 1990! While this could surely help boost the bubble, practically I doubt that there will be many takers. So one of the four props that kept our economy up in 2009 is unlikely to work in 2010. The interest rate prop is now working in reverse, as the RBA resumes its eternal fight against the consumer price inflation dragon, leaving only fiscal stimulus and China to counteract the decline in credit-based spending.

This is the real folly of boosting the economy by enticing households to take our more debt. Since spending is the sum of income plus the change in debt, increasing debt levels provide a strong boost to the economy. But that same process can work in reverse if households decide that they’re carrying too much debt: then their attempts to reduce their debt—”deleveraging”—necessarily reduces their spending.

When debt levels are low—as they were back in the 1950s and 60s—this isn’t a major problem. But when debt is as high as it is now—literally 100% of GDP for households and another 60% for businesses—then deleveraging can cause a dramatic fall in demand.

This is the force that is driving the downturn in the rest of the OECD, and by adding to household debt, we have simply delayed its arrival here—we have not stopped it.

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122 Responses to It’s Debt, Debt, Debt for Australia!

  1. Alan Gresley says:

    Oddly enough, debt, debt, debt for Australia seems to increase waste, waste, waste for Australia.

  2. Ftoomsh says:

    I get annoyed by that “Steve Keen is wrong” prompt on Google search. Fact is, Steve Keen will soon be proved right. What people don’t understand about macro predictions is that the micro behaviours and timings are not being and cannot be predicted in detail but rather the macro event in total. The macro event can be predicted with axiomatic certainty.

    It is axiomatic that endless growth (in population, energy consumption or debt for example) cannot continue idefinitely in a finite system. Why do most people find this concept so difficult to grasp? I think the answers are (a) they do not understand the power of exponential growth and (b) they think “big” equals “infinite”. Deep down they think, “The earth is so big, we’ll never run out of resources.”

    Since debt growth cannot continue indefinitely and since debt money is keeping economic activity robust then a crash or some kind of controlled crash landing must happen. It is axiomatic. When one guy (Steve Keen) talks about measurable quantities and empirical correlations and ties it together with a coherent theory while another guy talks about nebulous phenomena like “business confidence”, I know which bloke I will believe.

  3. Ftoomsh says:

    What is the way forward?

    Empirical evidence to date indicates that neither a pure command economy nor a pure free market economy can generate the best socioeconomic outcomes. Some form of mixed or hybrid economy is required and in fact always arises naturally because the political sphere constantly obtrudes itself to some extent onto the economic sphere. Concomitantly, the economic sphere, in an open society, always manages to quasi-escape efforts at regulation.

    We need to;

    1. Further develop the new heterodox economic theories which are already clearly superior in descriptive and predictive terms to the neoclassical economic practice which gave us the GFC.

    2. Re-introduce sufficient financial regulation to curb speculative excesses without unduly hobbling innovation and entrepreneurship. This would involve recognition that there is a theoretical optimum level for regulation as both too little and too much regulation carry avoidable costs. Highly speculative financial instruments ought to be severely curtailed or proscribed outright. The fractional reserve system may also require tighter controls to avoid excess debt creation.

    3. Negative externalities need to be costed or taxed. Perverse subsidies (for example negative gearing, fossil fuel subsidies, first home owner grants, business and middle class welfare and so on) need to be withdrawn progressively from the system. Even welfare for the poor ought to be provided on a self-interested cost-analysis basis only. The question ought to be about how much welfare taxpayers are prepared to pay through taxes to both insure themselves against ultimate personal misfortune and to avoid the very real disutilities of social ills such as poverty induced crime and poverty induced disease epidemics.

    The structural problems in our economy have arguably arisen, in part, out of progress in labour saving technology but have been greatly exacerbated by inappropriate policies. Perverse subsidies, industry assistance (corporate welfare) and anti-worker laws distort our economy in ways which artificially and deleteriously increase the profit share of the economy and reduce the labour share. The result is market-failure/policy-failure unemployment and under-employment which are in actuality much higher than the mendacious official measures.

    Capital gets a greater proportion of the cake but the cake is smaller overall because 10% of the bakers are not working. Economic activity and growth is only stimulated by ever increasing debt to underwrite consumption levels. Returning a greater share of profit to productive labour and productive invention will assist in correcting our economy.

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  5. utilitarian says:

    For those who haven’t seen it, “Mary Poppins on British Bank Stability”:

    http://www.youtube.com/watch?v=C6DGs3qjRwQ

    The user that posted has edited it slightly, but not too hard to put up with in a short clip.

  6. TruthIsThereIsNoTruth says:

    mahaish @86

    Thank you that is a nice simple starting point to anchor down your thoughts.

    I think again it is an example how something so intuitively simple gets very complicated in practice. First thing if assets were to equal liabilities both sides have to account for these positions in exactly the same way. Then I think these assets and liabilities can be passed on in many ways to different places which roll up in terms of reporting to different accounts which may or may not report into CAD or trade balance etc. Throw in interest rate swaps and cross currency swaps.

    So I think I agree with you and bb, theoretically it should balance out but in practice the accounting in the system makes it impossible to reconcile everything. I think this is an important thing to consider especially when looking at comparisons between different countries.

  7. spooky2009 says:

    Its ok,
    no one worry anymore.
    Everything is fine.
    Housing prices are going to continue to go up.
    And the economy is recovering nicely all in 2010

    Crisis Over
    http://www.news.com.au/business/recovery-to-gather-pace-in-2010/story-e6frfm1i-1225814879826

    Im running out now to buy some Bond corp shares before they boom, i hear they are very good value now.

  8. spooky2009 says:

    Its ok,
    no one worry anymore.
    Everything is fine.
    Housing prices are going to continue to go up.
    And the economy is recovering nicely all in 2010

    Crisis Over
    http://www.news.com.au/business/recovery-to-gather-pace-in-2010/story-e6frfm1i-1225814879826

    Im running out now to buy some Bond corp shares before they boom, i hear they are very good value now.

  9. bb says:

    Alan @ 100, and TITINT @ 106,

    Thanks for your thoughts.

    The bottom line is that the CAD (deficits) and CAS (surpluses) should balance. The fact they do not cuts to the very heart of all econimic debate. If we can’t measure the data correctly, how do any of these ratio’s mean anything.

    I asked Steve earlier in this blog a couple of questions. I know he is very busy, so I will open it up to everyone.

    1. With regard to Steves first chart, why has US household debt / GDP been flat over the past 2 years, despite +US$1.0t of debt forgiveness (write-downs) which is roughly equal to 7% of GDP

    2. Again with the first chart, why had the household debt / GDP been increasing since 1960’s while the US saving ratio was positive?

    3. How do the national accounts adjust the Current account surplus for losses / gain on equity investments. Ie: Japanese losses on Aussie real estate duing the early 1990’s.

  10. BrightSpark1 says:

    Alan Gresley

    I know Australia’s raw materials are of value but even in the middle of the “minerals boom” Australia’s CAD was in excess of 50 billion dollars per year.

    Also many mining assetts have already been aquired by foreigners in our “foreign investment” binge, soon we will not own any, or very few of them.

    We now depend on imports to keep our retail sector going even many food items are imported. Our deindustrialisation is almost at the end point with our TAFE and University sectors gutted. These institutions are now mainly educating into non wealth creating vocations and taking overseas students who enrol to gain permanent redidency not an education.

    Re industrialisation will take several decades and the transition will be very painful.

    The notion of a “post industrial” era is a totally stupid concept. History shows that the only way to gain real wealth is through being industrious.

  11. TruthIsThereIsNoTruth says:

    bb,

    another anomaly happens in the first chart in 1989 then the same anomaly seems to happen in the second chart in 1990 for Australian debt.

  12. BrightSpark1 says:

    Philip @99

    Once again sorry about the confusion.

    MVH Market Value Hypothesis a term that I thought you had used in a previous post.

    For the currency to self adjust as these idiots claim that it would, you would need constant interest rates and honest bankers at the very least. Fat chance!

  13. The Outback Oracle says:

    Hi Mahaish
    Always good to read your posts.

    I was actuaqlly agreeing with you. Latvia has little choice but to tell everyone outside Latvia to go and jump in the lake. I just thought it was simpler if they straight out told everyone so rather than go through the trouble of adjusting debt into Latvian currency. Frankly I don’t know how they would achieve that anyway but I’m ignorant in the niceties of such matters. Angophera pointed out that there may be two legal outcomes depending on which one adopted.

  14. The Outback Oracle says:

    bb

    We’ll have to agree to disagree I think re CAD’s, debt and Capital Surplus’. My thinking is rather ‘old fashioned’ and I guess a bit ‘Austrian’ in modern parlance. As I’ve said before i’m old enough to have existed before ‘Austrian’ became a theme and more call myself ‘a realist’.

    I would make one last comment on the subject which is not meant as a winning shot in any form. I feel that much modern thinking is distorted by consideration of the fact that we have economies that are so deeply in debt that, for most commentators, a positive after tax, real interest rate is regarded as impossible from a practical viewpoint. Thereofe the idea that negative interest rates are the basic cause of the problem is not considered at all. My view starts from a long time ago before we had all this damned debt. I can see quite clearly that had we had positive real interest rates much of our current problems would not have occurred.
    I do run into a problem with the value of the $A if other countries had adopted the debt fuelled growth model that in fact has been the fundamental mechanism of the years. So somehow we have to hold down the dollar while at the same time having higher interest rates. There are better brains than mine that might come up with possible solutions to this problem,,,hehe including yours!!!

  15. Goldilocksisableachblond says:

    bb @ 109 :

    “why has US household debt / GDP been flat over the past 2 years, despite +US$1.0t of debt forgiveness (write-downs) which is roughly equal to 7% of GDP”

    Just a guess , but with cash-for-clunkers, home buyers credits and such , there may have been offsetting creation of new debts. Meanwhile , GDP has been pretty flat.

    I agree that the rising savings with rising debt is counterintuitive. Maybe they should categorize those savings as ” debt-service reserves”. :)

  16. Alan Gresley says:

    @BrightSpark1 110

    “I know Australia’s raw materials are of value but even in the middle of the “minerals boom” Australia’s CAD was in excess of 50 billion dollars per year.”

    Very true. If it wasn’t for the rise of China and the Asian Tigers which lead to the resource boom, we would have had our Banana Republic but strange that should come from the person that also allow Globalization to sweep across Australia.

    “Also many mining assets have already been acquired by foreigners in our “foreign investment” binge, soon we will not own any, or very few of them.”

    And this should be reversed. Our current cream of political and financial elites has sold us out and seem intend on intensifying this process. The could be stopped buy our real estate bubble bursting and Debunking Economics being taught at school.

    “We now depend on imports to keep our retail sector going even many food items are imported. Our deindustrialisation is almost at the end point with our TAFE and University sectors gutted. These institutions are now mainly educating into non wealth creating vocations and taking overseas students who enroll to gain permanent residency not an education.”

    Australian generally didn’t realized the attention of the Hawke and Keating governments (Fabians) by allowing globalization which accelerated the trend of deindustrialisation and didn’t realize the consequences of the Howard government selling off our public infrastructure or gutting pubic education. It is the hidden coup of the financial and political elites.

    http://en.wikipedia.org/wiki/Australian_Fabian_Society

    “Re industrialisation will take several decades and the transition will be very painful.”

    We usually have to learn the hard way. The young generation of Australians do not know of the recession of 1989-1991. I talk to my son and he is in total denial that a recession can happen. He considers it ok, to get a mobile lose it, and buy another one.

    “The notion of a “post industrial” era is a totally stupid concept. History shows that the only way to gain real wealth is through being industrious.”

    I liken the concept of Post-Industrial to Post-Human since they seem to have emerged from the same schools. Julius Huxley was the first to use the word ‘transhumanism’. We know what his brother Aldous Huxley wrote, ‘Brave New World’.

    http://en.wikipedia.org/wiki/Transhumanism

    Sound to me like eugenics. Charles Darwin wrote about the accent of Man while the Darwinist wrote about the descend of Man back into feudalism. If this is what is termed progress, they can take their New World Global Feudalism and shove it.

  17. bb says:

    Goldilocksisableachblond @115,

    I would have thought the cash for clunkers program would have reduced debt – maybe I just don;t understand how it works.

    Yes some new debt would have been taken on as a result of home buyers incentives, however at the same time the saving rate has gone through the roof….

    Curious.

  18. Jason Murphy says:

    bb *35 point 2

    Obviously to determine if a particular set of circumstances is “good” or “bad” depends on the objective.

    Most people argue from their personal perspective.

    For example, someone with a mortgage is unlikely to argue that higher interesr rates are good etc etc.

    If I see a number that is outside of what we have seen in the past I ask this question. Is there something different this time that will not meke it return to the pack over the term that past epcerience would indicate that it would?

    If you loook at the charts you don’t have to be WB to see household debt seems to map to mortgage debt, and that GDP has done nothing our of the ordinary.

    Therefire mortgage debt is the thing to consider.

    Without boring you with the couple of pages of thinking to get from there to the conclusion the way I am thinking is this:

    The extent to which the ratio of GDP can or will stay at the number it is now, or move higher, or move lower, has as one of the key terms in it’s function the amount of trade surplus, and the extent to which trade surplus is the hands of fewer entities, and the relationship is that of direct proportion.

    Not determinitive, just one driver.

    Maybe?

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  20. foxbat101 says:

    Is debt the issue or serviceability of debt??
    Oh i am reducing my debt position.
    Always have.
    Any loan i take out is fully amortized over the term of the loan.
    So is it debt that is the issue or the ability of the participants (borrowers) to pay that debt.
    Or unwillingness to pay, after all if someone will lend you money at 0% interest why not take it?
    I suppose it is like having a full set of sails heading on a yacht towards a cyclone. A wise captain will trim the sails right down.
    An even wiser captain will avoid the cyclone all together.
    An even wiser person would not own a boat at all.
    People need to learn not be told.
    So lets not worry about the teenagers having their first party, most of them will survive. The ones that get hurt will lick their wounds recover and do it better next time.
    After all money is only colored pieces of paper other people value:)
    Peter

  21. dippa says:

    Sadly, the Aussie housing bubble looks just like the Irish one, albeit perhaps a year or two away. In Ireland, in the space of less than 2 years we have seen in excess of 40% wiped off the value of houses and it won’t be over until significant debt deleveraging happens. Cheap money was the reason and it’s interesting to see exactly the same thing happening now in Australia with 110% mortgages and government grants. The coming down phase is going to be prolonged and painful for people and banks. At least you will have the option of devaluing your currency which Ireland doesn’t being tied to the Euro…

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