Bank Prof­its a sign of eco­nomic sick­ness, not health

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The record $6 bil­lion profit that the Com­mon­wealth Bank is expected to announce today is a sign of an econ­omy that has been taken over by Ponzi finance. Fun­da­men­tally, banks make money by cre­at­ing debt, and the amount of debt we’ve been enticed into tak­ing on is the sign of a sick econ­omy rather than a healthy one. The level of pri­vate debt that is actu­ally needed to sup­port busi­ness and main­tain home own­er­ship at his­toric lev­els (own­er­ship lev­els have fallen over recent years!) is pos­si­bly as lit­tle as one sixth the cur­rent level.

Because of that debt level, bank prof­its have gone through the roof as a share of GDP. Back before we had a finan­cial crisis—when debt lev­els were far lower than today—so too were bank prof­its as a share of GDP. A sus­tain­able level of bank prof­its appears to be about 1% of GDP. The blowout from this level to vir­tu­ally six times as much began when bank dereg­u­la­tion began under Hawke and Keat­ing, and then took off as Howard and Costello encour­aged every­one to become “Mum and Dad Investors”, which meant bor­row­ing money from the bank and gam­bling on share and house prices.

As read­ers of this blog know, I build mod­els of finan­cial insta­bil­ity, and in my mod­els, one symp­tom of an econ­omy that is headed for a Depres­sion is a rise in bankers share of income at the expense of work­ers and cap­i­tal­ists. The model below has yet to be cal­i­brated to the data, but the sim­i­lar­i­ties with the actual data are still omi­nous.

One empir­i­cal real­ity illus­trated by the model as well is that even if firms are the ones tak­ing on the debt (as they are in this model—it does not include house­hold bor­row­ing), work­ers are the ones that pay for this in terms of a declin­ing share of national income: ris­ing debt is asso­ci­ated with a con­stant profit share of GDP but a falling work­ers share.

When the cri­sis really hits,  both work­ers and cap­i­tal­ists suf­fer as bank income goes through the roof—leading to a Depres­sion. The only way out of this is to abol­ish large slabs of the debt, and coin­ci­den­tally to drive bankers share of income back down to lev­els that reflect is sup­port­ive role as a provider of work­ing cap­i­tal for firms—rather than a par­a­sitic role as the financier of Ponzi schemes.

This is the real debt story of our econ­omy right now. As the first chart above indi­cates, pri­vate debt is far higher than Gov­ern­ment debt, even after the increase last year due to Rudd’s stim­u­lus pack­age. Gov­ern­ment debt is cur­rently 5.5% of GDP, whereas pri­vate debt—even though it has fallen slightly due to busi­ness deleveraging—is over 150% of GDP: 27 times the size of Gov­ern­ment debt. The so-called debate that the major par­ties are hav­ing over the size of Gov­ern­ment debt is an embar­rass­ment.