Land of the Twee­dles

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Aus­tralia is once again prov­ing itself to be the Land of the Twee­dles. Though Labor and Lib­eral loudly pro­claim their dif­fer­ences, on the key eco­nomic issues, they’re (par­don the pun) car­bon-copies. Both agree that the Fed­eral Bud­get should be returned to sur­plus. Both believe that the “Global Finan­cial Cri­sis” (which Amer­i­cans and most of the rest of the OECD call “The Great Reces­sion”) is behind Aus­tralia, and the imper­a­tive now is to stop the growth in gov­ern­ment debt. And both would leave untouched spend­ing pro­grams that make us worse off by pro­mot­ing asset bub­bles rather than seri­ous invest­ment.

On their core eco­nomic beliefs, Twee­dledee and Twee­dle­dum are wrong. The GFC is still with us, and—certainly in Australia—government debt is not the key prob­lem. Gov­ern­ment pol­icy that aims to drive the bud­get back to sur­plus may instead drive the econ­omy back into reces­sion.

Though ‘Dee and ‘Dum rau­cously debate the level of gov­ern­ment debt, both the boom before the GFC and the cri­sis after it were caused by out-of-con­trol pri­vate debt. Ris­ing house­hold debt fuelled bub­bles in asset markets—particularly housing—across the OECD. While Dee and Dum con­cur that Aus­tralia was a respon­si­ble excep­tion to the global rule, the bub­ble in house­hold debt here was in fact big­ger than that in the USA—mortgage debt peaked at 74% of GDP in the USA in late 2007; Aus­tralian mort­gage debt peaked 14% higher, at 88% of GDP, in March 2010.

Fig­ure 1

Against this, the level of gov­ern­ment debt in Aus­tralia about which both Dee and Dum obsess is triv­ial. If gov­ern­ment debt is a seri­ous problem—an issue I return to later—then the USA might have some­thing to debate. Amer­i­can gov­ern­ment debt is 15 times larger than Australia’s—relative to our respec­tive GPDs. And Amer­i­can gov­ern­ment debt is 117% the level of mort­gage debt; while in Aus­tralia the ratio is less than 7%! That Dee and Dum can fill the air­waves with alarm about the level of gov­ern­ment debt in Aus­tralia is truly sur­real.

Fig­ure 2

Dee and Dum con­cur that we avoided the GFC because of our lucky rela­tion­ship with The Red Queen (China). There is some truth to this (they can’t be con­sis­tently wrong), but both avoid dis­cussing the major rea­son we boomed while the rest of the world slumped—which is that Dee encour­aged house­holds to keep on bor­row­ing money while the rest of the world was delever­ag­ing.

Dee and Dum don’t dis­cuss this policy—they call it the First Home Own­ers Scheme, I call it the First Home Ven­dors Scheme—because both wor­ship the sacred cow of ris­ing house prices. The twins both favour expen­sive afford­able housing—yes I know that’s a non­sense phrase, but we’re on the other side of the Look­ing Glass here. So they both main­tain, with­out dis­cus­sion, poli­cies designed to keep house prices high and ever ris­ing, while at the same time pre­tend­ing to make hous­ing afford­able with expen­sive poli­cies that help keep the bud­get in deficit.

That’s why, despite their obses­sion with reduc­ing the deficit, nei­ther Dee nor Dum will even dis­cuss three sim­ple pol­icy ideas:

  1. Limit the First Home Ven­dors Grant to new hous­ing only;
  2. Limit new Neg­a­tive Gear­ing to new hous­ing only; and
  3. Bring the cap­i­tal gains tax rate back into align­ment with the income tax rate.

These pol­icy changes would do won­ders for the Bud­get bot­tom line while improv­ing the economy—which both Dee and Dum claim they’re try­ing to do (“Trust us, we’re Twee­dles…”).

With roughly 100,000 First Home Buy­ers every year, 90% of whom buy an exist­ing prop­erty rather than a new one, the abo­li­tion of this house price sup­port scheme (that’s not what Dee and Dum call it, but that’s what it is) could save $600 mil­lion a year—and the con­tin­ued sup­port for new hous­ing might spur hous­ing con­struc­tion as the Boost did in 2008. That’s a rather more respon­si­ble way to save money than by cut­ting med­ical research fund­ing, which is one of the deficit reduc­tion kites Dee flew a month back.

Lim­it­ing neg­a­tive gear­ing to new prop­er­ties only would also do some­thing to increase the sup­ply of new hous­ing for renters. Both Dee and Dum claim that is the real goal of the cur­rent pol­icy, but despite their bleat­ings, every­body knows that, as a scheme to encour­age spec­u­la­tion on ris­ing house prices, neg­a­tive gear­ing is sim­ply another plank in their mutual house price sup­port scheme. So-called investors actu­ally do less real invest­ment than even owner-occu­piers these days—less than 2 per­cent of new dwelling finance goes to investors build­ing or buy­ing new prop­er­ties.

Fig­ure 3

If neg­a­tive gear­ing was restricted only to real investors—people who actu­ally build some­thing new, rather than buy­ing some­thing old and wait­ing for its price to rise—then renters might some­day be able to find some­where to rent.

Lim­it­ing neg­a­tive gear­ing to new prop­er­ties only wouldn’t affect cur­rent prop­erty spec­u­la­tors (I’m sorry, I meant investors)—at least not directly—but it would reduce the growth of this Bud­get-sap­ping Black Hole by 95% or more.

Finally, the deci­sion to halve the rate of cap­i­tal gains tax back in 1999 was one of the stu­pid­est things Dum ever did (when he was in power)—aand there­fore it worked a treat in Look­ing Glass Land. It costs the gov­ern­ment close to $10 bil­lion dol­lars a year—almost the amount of the deficit they’re both claim­ing to know how to reduce. And, like every­thing else Dee and Dum don’t bicker over, it pro­motes spec­u­la­tion over true invest­ment.

Now it’s the main cause of a blowout in the Bud­get deficit this year we’re told, as cap­i­tal gains have evap­o­rated from our anaemic share mar­ket and the now burst­ing house price bub­ble. So why not make the Bud­get hit less extreme by bring­ing the rate back to the same as that for income?

Are either of them likely to even dis­cuss abol­ish­ing this tax dis­tor­tion? Not on your Nel­lie. And the same goes for the other two poli­cies too, because behind their facade of debate, Dee and Dum both know that any­thing that would reduce house prices—and gen­uinely make them affordable—would lose them votes with the Look­ing Glass elec­torate. So even though these pol­icy changes would prob­a­bly elim­i­nate the deficit overnight—which they both claim to want to do—they will instead fight about how hard to hit the soft tar­gets of wel­fare recip­i­ents, uni­ver­si­ties and their own bureau­cracy.

Which brings us to the other issue on which they both agree: the need to reduce the gov­ern­ment deficit. Are they right?

In the inter­ests of pro­mot­ing healthy scep­ti­cism here, let me pro­pose a sim­ple rule of thumb: almost any­thing that Dee and Dum agree upon is likely to be wrong (and this applies in the USA as well to their Dee and Dum).

Firstly, gov­ern­ment debt didn’t blow out on its own accord: it grew because pri­vate debt stopped grow­ing. This is obvi­ous in the US data: gov­ern­ment debt fell after the 1990s reces­sion ended—and only rose since late 2001 because of for­eign wars. Gov­ern­ment spend­ing blew out in 2008, not because the Dumoc­rats took over from the Deep­ub­li­cans, as their polit­i­cal debate would have it, but because pri­vate debt-financed spend­ing col­lapsed when the hous­ing and stock mar­ket Ponzi Schemes ended.

Fig­ure 4

Sec­ondly, it’s a non­sense to argue, on an anal­ogy with house­holds, that gov­ern­ment debt can bank­rupt a gov­ern­ment that has a cap­tive Cen­tral Bank. If a house­hold spend more than it earns, then after it exhausts its sup­ply of credit, it is bank­rupt. But if a gov­ern­ment spends more than it taxes, it accu­mu­lates a debt to its Cen­tral Bank… which it can pay by bor­row­ing from its Cen­tral Bank. Unlike a pri­vate bank, a Cen­tral Bank can’t refuse to lend to its pri­mary bor­rower.

So Fed­eral Gov­ern­ment in the USA or Aus­tralia won’t go bankrupt—though their States could, as could the Euro­zone coun­tries of Europe. Hence, what should be dis­cussed are the eco­nomic con­se­quences of run­ning a deficit: assum­ing instead that a gov­ern­ment can run out of money is Twee­dle­Dum­ming down the prob­lem.

I apol­o­gise for com­pli­cat­ing the debate here—Tweedle-dumming a prob­lem is much more cathartic—but the indi­ca­tions are that this is not the time to be reduc­ing gov­ern­ment spend­ing in either the USA or Aus­tralia. The cri­sis was caused by accel­er­at­ing debt—which gives the econ­omy a boost—giving way to decel­er­at­ing debt—which dri­ves aggre­gate demand down. This is eas­ily shown by graph­ing the accel­er­a­tion of debt—the Credit Impulse—against changes in unem­ploy­ment (the cor­re­la­tion coef­fi­cients in the next two charts are –0.77 and –0.75—extremely high cor­re­la­tions over such a long period with such vari­able eco­nomic con­di­tions).


Fig­ure 5

Though Aus­tralia cer­tainly was assisted dur­ing the GFC by its sales of coal and iron ore to the Red Queen, the real rea­son that it “avoided” the GFC was that it restarted the pri­vate debt engine more rapidly than Amer­ica did. The Credit Impulse stopped its plunge at –12 per­cent of GDP here, ver­sus a peak neg­a­tive of –26 per­cent in the USA. Aus­tralia also spent less time in the red on the Credit Impulse than the USA: 26 months ver­sus 30.

Fig­ure 6

Now both economies are recov­er­ing, not because the phys­i­cal economies are in good shape—they’re both very sick, except for Australia’s min­er­als sector—but because the Credit Impulse has turned pos­i­tive in both coun­tries.

Fig­ure 7

This, how­ever, is not a sus­tain­able path to recov­ery.

Firstly, bor­row­ing money and gam­bling on ris­ing asset prices is what got us into this cri­sis in the first place: rely­ing on a recov­ery in pri­vate debt to get us out of this slump is like pre­scrib­ing more can­cer as a cure for can­cer.

Sec­ondly, it’s highly unlikely that either coun­try can sus­tain the accel­er­a­tion in debt that is needed to keep the Credit Impulse pos­i­tive, because if they did, then at some point falling debt would have to give way to ris­ing debt once more. Call me crazy, but I just can’t see that hap­pen­ing.

Fig­ure 8

So what is likely to hap­pen soon—and sooner for Aus­tralia than for America—is that the pos­i­tive boost from the Credit Impulse will run out, and turn neg­a­tive again. If, at the same time, the government’s input turns neg­a­tive cour­tesy of deficit reduc­tion, then the reces­sion will return.

Ulti­mately, the only way out of this cri­sis is to abol­ish the debt that caused it: debt that financed spec­u­la­tion on ris­ing share and house prices rather than to finance gen­uine invest­ment. As Michael Hud­son puts it so sim­ply, debts that can’t be repaid, won’t be repaid. At some stage—maybe ten years after the Great Reces­sion began, we’ll finally learn the truth of that elo­quent apho­rism, and tackle the real cause of this cri­sis.

But until then, we’ll dis­tract our­selves by watch­ing the point­less debate between Twee­dle­dum and Twee­dledee.

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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  • Anti­Moral­Haz­ard


    Home loan fall points to hous­ing weak­ness”

    I noticed this para­graph in that arti­cle:

    A brighter spot in the fig­ures was a rise in the amount of finance taken out by hous­ing investors, which lifted 2.1 per cent.

  • I liked Malaya’s com­ment. The ponds at $640k is way over the jus­ti­fyable (and afford­able) price level. I had a house in the area that I sold last week because I’d rather use 6.5% no risk cash rate and rent a larger place instead.
    Defi­nately agree with your com­ment about rates. Don’t for­get elec­tric­ity: we just got a bill for $650 for 2 months. Energy and food prices are up, and that’s why the gov­ern­ment is sug­gest­ing that the national income is up and “aus­tralians are get­ting wealth­ier”.
    The fact is you are right — it is get­ting more and more expen­sive to live.

    I made a fun YouTube video to explain what is actu­ally hap­pen­ing with the “wealth increase” and what the gov­ern­ment is doing:

    Whilst I am not as rad­i­cal as Steve Keen, and do not pitch the prop­erty col­lapse as Chris Kayce (who then tells you to by micro-cap min­ing stocks), I have also analysed the debt issues, risks and default pos­si­bil­i­ties and pub­lished a book called “Why you need a Finan­cial Adviser”

    Read it and esp­cially look at pages 44–57. I think Steve will love that too! Your adviser may not be telling you this either because they are purely sales-peo­ple or they merely do not com­pre­hend.
    So I agree with Steve on not all but rather many issues. Let me know if you liked the resource.


  • Steve,

    did you also see research on US auto-bonds which are effec­tively sub­prime debt + non-per­form­ing car loans? 


  • No inkmwealth; I know of them and how Dodgey they are (couldn’t resist the pun), but I haven’t seen detailed research. They seem a clas­sic case of “churn” prof­its: lend to some­one who can’t afford the repay­ments, repos­sess and sell again.

    By the way every­one, I depart for the Ukraine and Rus­sia on Sun­day, and am away for about ten days. So I’ll be slow on both com­ments and approvals in the mean­time.

    I have also had a series of cata­tonic com­puter has­sles: my desk­top crashed (age­ing video card), and the lap­top failed (but the prob­lem was later iden­ti­fied as a BIOS set­ting that caused the BSOD has­sles I’ve had for the last 15 months!). So I’ve been in a com­puter night­mare for the last week, and that has slowed a num­ber of tasks that I hope to get on to in July.