There is no GFC

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One of the unex­pected things I’ve learnt in Boston is that the Global Finan­cial Cri­sis is not called the Global Finan­cial Cri­sis in America–and there­fore the TLA of the GFC has no mean­ing here.

Instead, in Amer­ica this might be The Cri­sis That Has No Name (TCTHNN), because they don’t call it any­thing at all: it’s just how the econ­omy is right now.

Aus­tralians, it seems, are the ones who invented the moniker GFC as a way of describ­ing what they think they don’t have to under­stand. Over here, where it is actu­ally hap­pen­ing, it is just the day to day real­ity that must be con­tended with.

Even more pecu­liar is news from some finance sec­tor insid­ers here who have been in touch with Australia’s RBA and Trea­sury, that they describe it as not the GFC, but the “North Atlantic Finan­cial Cri­sis” (“NAFC”)–arguing once again by a label that this cri­sis is pecu­liar to the US and Europe.

Appar­ently when asked what Aus­tralia has learnt from the cri­sis, the answer was often “Noth­ing, because it didn’t hap­pen here”. The Lucky Coun­try, it seems, is seen as immune to the cri­sis by its eco­nomic man­agers.

I know that I’m more likely to be spo­ken to by Bears in Boston than Bulls, but even the Bulls find this Aus­tralian complacency–even smugness–about the cri­sis bemus­ing. One insider I spoke to–admittedly a Bear–commented that he found it so annoy­ing on his last visit to Aus­tralia that he’s sworn never to return.

Good rid­dance might be the atti­tude of some; who needs the neg­a­tiv­ity? Well, we might, if the causes of the cri­sis are not in fact pecu­liar to the North Atlantic.

For though the GFC might have had very lit­tle bite in Aus­tralia to date (and I admit that the mild­ness of the down­turn to date in Aus­tralia did sur­prise me) we can only kiss it good­bye if it was really just a North­ern Hemi­sphere Black Swan. If instead its causes are more gen­eral, then as the US now starts to fear a DDR (Dou­ble Dip Reces­sion), Aus­tralia might find that it’s not so Lucky after all.

Here there is one indi­ca­tor that I think explains why Aus­tralia has not suf­fered as badly as its North Atlantic coun­ter­parts, but also why there will be no easy recov­ery: the con­tri­bu­tion that ris­ing debt makes to aggre­gate demand. Though I am a critic of the extent to which our economies have become debt-depen­dent, there’s one unmis­take­able fact about our post-1970 recov­er­ies: they have all involved a ris­ing level of pri­vate debt com­pared to GDP.

I’ve recently done a com­par­i­son of how the US today com­pares to the US in the 1930s on this front, and the results–published in an ear­lier post–were intrigu­ing.

The US was actu­ally suf­fer­ing a more severe pri­vate sec­tor delever­ag­ing this time than in the 1930s: in 1928, ris­ing debt was adding about 8% to the level of aggre­gate demand. That is, demand was 8% higher than it would have been had debt been con­stant. By the depths of the Great Depres­sion, falling debt was mak­ing aggre­gate demand about 25% lower than it would have been had debt been con­stant.

The story for today is more extreme: at the end of 2007, ris­ing debt made aggre­gate demand 22% higher than it would have been had debt been constant–so ris­ing debt today was almost three times as impor­tant in our pre-GFC boom as it was in the 1920s. Two and a half years later, falling pri­vate sec­tor debt was reduc­ing demand by almost 15%. This was not as bad as the worst lev­els of the Great Depres­sion, but worse than in 1931, which was the com­pa­ra­ble time from the begin­ning of the down­turn in pri­vate debt.

The pos­i­tive dif­fer­ence between then and now in the USA turned out to be the con­tri­bu­tion to demand made by ris­ing Gov­ern­ment debt. The gov­ern­ment-financed pro­por­tion of demand in the Great Depres­sion was triv­ial two years into the cri­sis, and only became substantial–at about 7.5% of aggre­gate demand–three years in. In con­trast, gov­ern­ment spend­ing is mak­ing aggre­gate demand almost 13 per­cent higher now. But even then, the USA is still delever­ag­ing.

That’s the com­par­i­son the the USA today with itself 80 years ago; what about the com­par­i­son of the USA today with Aus­tralia today? The chart below pro­vides it.

Firstly, Aus­tralia is run­ning a cou­ple of months behind the USA in the cri­sis. But that’s minor com­pared to the dif­fer­ence in scale. Pri­vate debt added slightly less to demand in Aus­tralia dur­ing the boom times–a max­i­mum of 18.75% of aggre­gate demand was financed by pri­vate debt, com­pared to over 22% for the USA. But delever­ag­ing hasn’t even begun here: the pri­vate-debt-financed con­tri­bu­tion to demand flirted with zero in late 2009, but has been pos­i­tive through­out. Ris­ing pri­vate sec­tor debt today is adding about 2% to aggre­gate demand. Ris­ing gov­ern­ment debt is adding about another 2 per­cent on top of that.

So Aus­tralia hasn’t yet delevered–in con­trast to the USA. Does that mean we have a “get out of the GFC Free” card? That depends on whether we’ve avoided what caused the GFC in the first place–a runup of exces­sive pri­vate debt dur­ing a spec­u­la­tive bub­ble.

There the answer is equiv­o­cal. While we have sub­stan­tially less debt than the USA (though some cor­re­spon­dents have argued that the RBA fig­ures I use under­state the level of finance sec­tor debt here), our debt to GDP ratio is 90% higher than it was back in the Great Depres­sion.

So we have less delever­ag­ing poten­tial than the USA, and we haven’t even begun to do it yet–which is why the GFC has appeared to be a North Atlantic phe­nom­e­non. And if we can pre­vent delever­ag­ing, then we won’t see the depths of the down­turn that the North Atlantic has seen either.

But there is a down­side to no delever­ag­ing. We have a house­hold sec­tor that is even more indebted than its US coun­ter­part. The odds are that this sec­tor will be debt-con­strained in its spend­ing, and the recov­ery will be stalled as a result. So the GFC is not entirely a NAFC.

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.
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