A Fork in the Road?

Flattr this!

The RBA and most con­ven­tion­al mar­ket econ­o­mists see 2011 as the year in which our biggest chal­lenge will be “man­ag­ing pros­per­i­ty”. The min­ing boom will keep the mon­ey flow­ing, and the econ­o­my will just have to cope with the struc­tur­al change that results.

There’s no doubt that Chi­na’s demand for our min­er­als has gen­er­at­ed enor­mous rev­enue for the coun­try, by giv­ing us the best terms of trade in the last half cen­tu­ry, and turn­ing our trade bal­ance into sur­plus.

If these were the only forces deter­min­ing our future, then the expec­ta­tion that our major eco­nom­ic prob­lem in the future will be infla­tion dri­ven by sup­ply con­straints (main­ly labour short­ages lead­ing to a wages break­out) could well be cor­rect.

But there are also the forces of cred­it.

The “man­ag­ing pros­per­i­ty” crowd failed to con­sid­er these pri­or to the Glob­al Finan­cial Cri­sis, which is why they did­n’t see it com­ing while a hand­ful of non-ortho­dox econ­o­mists did—including yours tru­ly (Beze­mer 2009; Beze­mer 2010; Full­brook 2010).

If these forces had been tamed, then good times could well lie ahead. Equal­ly, if they had turned decid­ed­ly pos­i­tive again—so that cred­it growth was boost­ing the econ­o­my rather than slow­ing it down—then boom times could be in the off­ing, though with an inevitable day or reck­on­ing still in the future as our debt to GDP lev­el mount­ed.

When I pre­dict­ed the GFC, I was rely­ing on the ratio of pri­vate debt to GDP and its growth rate as indi­ca­tors of a loom­ing eco­nom­ic cri­sis. In both Aus­tralia and most of the OECD, debt to GDP lev­els had been ris­ing expo­nen­tial­ly, tur­bo-charg­ing aggre­gate demand; it was to me (and many oth­er non-neo­clas­si­cal econ­o­mists) all too evi­dent that, at some stage, this growth of pri­vate debt would have to cease. When it did the mere fact that its rate of growth had slowed would cause a major reces­sion.

That turn­around in the pri­vate debt to GDP ratio that I first pre­dict­ed in 2006 com­menced in 2008, and the slow­down in the rate of growth of debt that pre­ced­ed the peak was the key force behind the finan­cial cri­sis that began in late 2007.

The eco­nom­ic cri­sis that ensued was as big as I expect­ed, though its sever­i­ty has been atten­u­at­ed by the largest gov­ern­ment stim­u­lus pro­grams in human his­to­ry. How­ev­er the Aus­tralian econ­o­my per­formed far bet­ter than I expect­ed, and it could be argued—and has been argued to my face—that I got it wrong about Aus­tralia.

I cer­tain­ly got the empir­i­cal pre­dic­tions wrong. I expect­ed that unem­ploy­ment would hit dou­ble dig­its here, as it has else­where in the OECD (the US fig­ure of below 10 per­cent reflects its pecu­liar unem­ploy­ment scheme plus under­count­ing of dis­cour­aged work­ers). Instead, it peaked at 5.8% and has since fall­en to 5.2%.

It would appear that there are two pos­si­ble inter­pre­ta­tions of this: either Aus­tralia real­ly was dif­fer­ent, and eco­nom­ic prin­ci­ples that apply to the rest of the globe don’t apply here, or my under­ly­ing mod­el of how a mar­ket econ­o­my works was wrong.

Option 2 was unlike­ly since the cred­it-dri­ven, Hyman Min­sky ground­ed approach I’ve always tak­en to eco­nom­ics did pre­dict the cri­sis, and in the rest of the OECD it remains a deep and seem­ing­ly intractable cri­sis. So was Aus­tralia just the excep­tion that proves the rule?

No. In fact, the data sup­ports a third option: that Aus­trali­a’s posi­tion as a min­er­als exporter to Chi­na does make it some­what dif­fer­ent, but the fun­da­men­tal mod­el of a cred­it-dri­ven eco­nom­ic cycle applies here too. It’s just that a pecu­liar­ly Aus­tralian gov­ern­ment policy—the First Home Ven­dors Scheme—turned the cred­it engine to our favour dur­ing the GFC. Where­as the rest of the devel­oped world became mired in delever­ag­ing, we lever­aged our way back towards pros­per­i­ty.

Pri­vate debt has gone from ris­ing by US$4.5 tril­lion in the USA—thus adding $4.5 tril­lion to aggre­gate demand—to falling by $2.5 tril­lion, and thus sub­tract­ing from aggre­gate demand there. This was the fac­tor that drove the US from boom to near-Depres­sion.

But though Aus­tralia began the delever­ag­ing process, it stalled it just as the change in debt approached zero. The increase in debt since then has been a major fac­tor in why our unem­ploy­ment rate stopped increas­ing, and has since fall­en.

The com­mon fac­tors dri­ving the two economies (and there­fore the dif­fer­ence in their eco­nom­ic out­comes to date) is stark­ly evi­dent when one con­sid­ers the “cred­it impulse”—or the rate of accel­er­a­tion of debt. The turn­around from accel­er­at­ing debt pro­pelling the change in aggre­gate demand to decelerating—falling—debt sub­tract­ing from the change in aggre­gate demand was the great­est the US has ever expe­ri­enced, since and includ­ing the Great Depres­sion.

The rever­sal of this debt decel­er­a­tion is also evi­dent in that chart of course—and the com­men­su­rate slow­down in the rate of the increase in unem­ploy­ment. Gov­ern­ment pol­i­cy clear­ly played a large role in this—the pri­vate sec­tor was hell-bent on delever­ag­ing before the US’s mas­sive fis­cal stim­u­lus and QE1.

Now check out Aus­trali­a’s sto­ry over the same time period—and at the same scale. We got out of the cri­sis before we real­ly got into it by revers­ing the pri­vate sec­tor’s trend to delever­ag­ing, and encour­ag­ing bor­row­ing once more.

Can we keep on bor­row­ing our way to pros­per­i­ty? Here’s where I turn cyn­ic once more: we could, if we did­n’t already have an unprece­dent­ed lev­el of pri­vate debt, with both house­holds and busi­ness­es car­ry­ing more debt than they’ve ever sus­tain­ably car­ried in the past.

This implies a lim­it to the cred­it impulse (both in Aus­tralia and over­seas). For the cred­it impulse to remain pos­i­tive, then ulti­mate­ly the debt to GDP ratio must start ris­ing, and keep ris­ing. But with the econ­o­my so heav­i­ly indebt­ed already, the cred­it impulse is like­ly to peter out and give way to decel­er­at­ing debt once more—with a neg­a­tive impact upon aggre­gate demand.

This is already start­ing to turn up in the data. The cred­it impulse graphs so far con­sid­er the change in the change in debt over a year; this next graph con­sid­ers the accel­er­a­tion in debt on a month by month basis as well. Though the month­ly data is very volatile, only 3 of the last ten months’ cred­it impuls­es have been pos­i­tive.

This indi­ca­tor tends to lead changes unem­ploy­ment by about three months. A sus­tained run of neg­a­tives could be enough to gen­er­ate yet anoth­er “unex­pect­ed” increase in unem­ploy­ment next year.

This returns me to the bot­tom line of my cred­it-ori­ent­ed analy­sis. Sus­tained recov­er­ies from reces­sions in Aus­tralia and the whole OECD in the last 40 years have all been accom­pa­nied by ris­ing lev­els of pri­vate debt to GDP. I sim­ply don’t believe that’s pos­si­ble now.

When the Aus­tralian econ­o­my has hit the skids in the past, the recov­er­ies that ensued – in 1975, 1983 and 1993 – were all accom­pa­nied by increas­es in bor­row­ing. Cred­it growth boosts invest­ment and job cre­ation, and every­one’s hap­py. Hap­pi­ness of the debt-financed kind will be short-lived in 2011, because we’re already past the peak lev­el of debt that we’ve ever had, or are like­ly to have.

So I expect Aus­tralia to resume delever­ag­ing dur­ing 2011, lead­ing to reces­sion-like con­di­tions in sec­tors that are not major ben­e­fi­cia­ries of the Chi­na Boom. We are already see­ing the first casu­al­ty – retail­ers are dis­count­ing well before Christ­mas, rather than after it, and the “unex­pect­ed” drop in retail sales last month is some­thing I expect­ed to see when the First Home Ven­dors Boost wore off. Retail­ers’ pain will only increase through 2011.

My advice to the opti­mists is to take their eyes of Chi­na for a few min­utes and take a good hard look at the direc­tion cred­it aggre­gate data is mov­ing – it’s down, and unfor­tu­nate­ly that’s where two thirds of the Aus­trali­a’s “three-speed econ­o­my” could well move next year.

Last­ly, let’s also take a slight­ly longer term look at the rela­tion­ship between our exports and imports. We are cer­tain­ly ben­e­fit­ing from pos­i­tive net exports right now. But his­to­ry’s les­son is that that boost can dis­ap­pear very quick­ly.

Beze­mer, D. J. (2009). “No One Saw This Com­ing”: Under­stand­ing Finan­cial Cri­sis Through Account­ing Mod­els. Gronin­gen, The Nether­lands, Fac­ul­ty of Eco­nom­ics Uni­ver­si­ty of Gronin­gen.

Beze­mer, D. J. (2010). “Under­stand­ing finan­cial cri­sis through account­ing mod­els.” Account­ing, Orga­ni­za­tions and Soci­ety
35(7): 676–688.

Full­brook, E. (2010). Keen, Roubi­ni and Bak­er win Revere Award for Eco­nom­ics. Real World Eco­nom­ics Review Blog. E. Full­brook. New York, Real World Eco­nom­ics Review. 2010.

Bookmark the permalink.

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.