And I do also want to have some fun–it isn’t all sour grapes! As someone who has done graphic design at various stages in my life, I like the look of the “fit text to curve” text–it’s the T-shirt I’d like to have in my collection. So what I’ve decided to do is to produce at least 4 of the 5 T-shirts shown below, two of which have text fitted to the curves, and three of which do not.

In one of the text-to-curve cases, the text is easily legible–unlike the earlier design with US, Japanese and Australian house prices where the text overlapped; in the second, it’s an effort to read, partly because of the coloured text–but I want at least one shirt with a full range of colours.

I’ll alternate wearing the T-shirts on different days and stages of The Walk, and I will suggest to the (so far) three people who are going to do the whole route with me that we each wear one of them at the start at Parliament House.

I have also changed to the modern and linguistically accurate spelling of Kosciuszko, and I’ve added the references to the two blogs on the front of the shirt as well as the back, following suggestions from the blog.

Each of the shirts has a graphic to tell part of the story about why we’ve had a house price bubble–debt, government manipulation with the FHVG, and time. There were one or two suggestions about doing the T-shirt with just words (and adding an answer to the question).

I’d prefer to keep some information content in them that may be relevant in a future when the bet itself is no longer remembered.

All that makes the T-shirts rather busy–which detracts from the aesthetics–but in the balance between information and appearance, I’ll bias in favour of the former.

The only shirt I’m unsure of is the last, showing mortgage debt to both household disposable incomes and GDP (the reason I have both there is that the fall in the ratio to disposable income at the end was because the impact of the government’s stimulus package and RBA rate cuts on household disposable income was actually larger than the increase in mortgage debt caused by the FHVB; that’s why that ratio fell while the mortgage debt to GDP ratio rose).

So the five designs are:

Design No. 1

Design No. 2

Design No. 3

Design No. 4

Design No. 5

As I explain on www.keenwalk.com.au, I was ambushed with this bet in front of an audience of 80-100 people at Parliament House. I have responded in kind by turning the walk into a protest about the manner in which keeping property prices high has come to dominate economic policy in Australia–with what I prefer to call the First Home Vendors Boost being the most outrageous example of that.

The designs for the T-Shirt continue this theme. I will produce at least 3 of designs shown below.

Design No. 1 highlights the impact of the First Home Buyers Grant over the last 30 years. It was first introduced in 1983 by the Hawke Labor Government, then expanded in 1988 as a way of boosting the economy when it was feared that the economy could enter a recession. It was reincarnated by Howard in 2000 as a temporary boost to help the housing sector adjust to the GST, then temporarily doubled in 2001 as part of a stimulus package to avoid a recession, and of course most recently doubled again in September 2008 by the Rudd Government as part of its anti-GFC package.

The graph shows the ratio of house prices to household disposable income from 1980 until now, with the dates on which the Grant was either introduced or doubled marked by the dotted lines. It’s obvious that the Grant triggered growth in the real cost of housing every time, with its most spectacular “successes” being in 1988 and 2001.

Unlike some commentators, I don’t blame the government entirely for the house price bubble–there I point the finger at a financial system which is always willing to finance a Ponzi Scheme when one can be found. But it’s clear that the First Home Owners Grant seeded the Ponzi Scheme by setting off a buying frenzy every time it was introduced.

Design No. 2 highlights what has always been the main game for me: the growth in Australia’s debt to GDP ratio, driven by lending for speculation rather than lending for productive investment. This is the third debt bubble in Australia’s economic history since 1860, and it is by far the biggest.

Debt: the engine beneath the bubble

Since nothing has been done about this debt level–in fact, Australia has in part got out of the GFC by encouraging debt levels to grow once more–this is still the force that I expect to see dominate Australia’s future economic performance. If private debt continues to rise, then the apparent post-GFC boom will continue. But if the household sector joins the business sector in deleveraging, then the change in debt will drive aggregate demand down and Australia will find that the GFC is not quite behind it.

The most recent data indicates that the bubble in household debt burst in the month that the First Home Vendors Boost expired. In “Home loans slump most in a decade“, Chris Zappone notes that the ABS has reported that:

The number of home loans plummeted by 7.9 per cent in January, the biggest fall since June 2000, after the phasing out of last year’s first-home buyers’ grant boost and interest rate rises sapped demand.

January’s result follows a revised 5.1 per cent drop in December, the Australian Bureau of Statistics reported, citing seasonally adjusted figures. Economists had been predicting a 2 per cent increase in January…

Total housing finance by value fell by 3.3 per cent in January, seasonally adjusted, to $21.2 billion.

Design No. 3 shows just how far out of line Australia’s house prices are with the rest of the world. Japan had its own Bubble Economy period in the 1990s, which drove Japanese real estate prices up to a peak from which they have spent the last 20 years descending; the USA’s bubble took off in 1998 and peaked in 2006; but both these are dwarfed by Australia’s roller coaster rise ever upwards.

The Kangaroo Bubble vs the Setting Sun and the Very Bald Eagle

Nominal prices only ever fell once–in 2008 prior to the First Home Vendors Boost, which set off the latest bubble. Unfortunately, both sides of Australian politics mistakenly identified falling house prices as the cause of the GFC, and therefore agreed to this policy to inflate house prices even further, which was disguised as a means of helping new buyers into the market.

(Of course, the real cause of both the apparent prosperity before the GFC, and the GFC itself, was not the bubble in house prices and its bursting, but the bubble in private debt that provided the leverage that drove house and share prices up, and its bursting in 2007-08. This real cause was ignored by all politicians–and all but a handful of economists–until it was too late.)

Design No. 4 shows that Australian house prices have fallen when adjusted for inflation, and Australia’s inflation rate has been higher than that of Japan or the USA. But even after adjusting for inflation, our house prices are twice as high as America’s, and 2.5 times as high as they were back in 1986 when the ABS began recording them.

The Kangaroo Bubble vs the Setting Sun and the Very Bald Eagle

Finally, Design No. 5 emphasises the folly of projecting current trends in asset prices into the infinite future. This is the famous Herengracht Index, which tracks the real price of housing on Amsterdam’s wealthiest canal from 1628–just before the Tulip Bubble–until 1973.

350 Years of data from the land of tulips

If you had been born in, say, 1735, you might have died as an 85-year-old, convinced that house prices always fall, compared to consumer prices, since for most of that period house prices did in fact fall in real terms. However if you had been born in 1820, you might have reached our modern retirement age convinced that you could live off rising wealth from your housing assets–since they would have risen since you were born–only to find them declining for the next 60 years.

Finally, after focusing on the housed on the front of the T-shirt, the back turns its attention to those without homes: the logo is for Swags for Homeless, the brilliant Australian charity that is doing something now for the homeless, by providing a homeless person with a light, waterproof, fireproof portable bed for every A$60 donation that it receives. Click on the image below to make a donation to this very worthwhile cause.

As noted, I’ll produce at least three of the above designs. The minimum order I can make is for 15 copies of each T-Shirt, and the production costs are roughly $50 each. I will need to wear about 14 of these myself on the run; the others will be available for anyone who is willing to do the whole Walk with me (so far there are 3 takers).

I will also produce more copies if people are interested in buying them. If you’d like to buy a T-Shirt, then please make a donation to The Walk of $80 or more (for an Australian address) or $100 (for an overseas address) using the donate widget there. Be sure to specify which design (1 to 5) and your mailing address in the Comments field for the donation.

Designs 1 and 2 are certainties; I’ll also produce either Design 3 or Design 4, depending on feedback here. Design 5 may be produced if there is enough demand. If you want any of Designs 3-5, be sure to specify a fallback Design if we don’t get enough orders to go ahead with all 5 T-shirts (if you specify Design 3 or 4 and we actually make the other, we’ll automatically swap over since there is not a lot of difference between them).

Finally, if you want some anti-bank paraphernalia that is a bit more general than what I’m offering here, take a look at the site “I hate the nab“, where there is a range of T-shirts and other items for sale.

My apologies for the confusion. In any case, it looks like quite a few people were able to see past my slip and we now have about 15 members signed up for dinner this Tuesday at a rather nice venue in Sydney (I will stick to just letting people know where by return email). The cost for the dinner will be $65 per person, and it will start at 7pm at a venue not too far from Sydney’s CBD.

If you would like to join us, there’s still time for me to expand the numbers; just drop me an email at debunking at gmail dot com.

I will try to keep the formal side of the evening to a minimum. We have to:

Adopt a model constitution for Associations;

Agree for a few objectives specific to our own Association;

Nominate 3 names (one of which will be used to name the Association);

Elect office bearers (President, VP, Treasurer and Secretary) and 3 ordinary members of the Committee.

Some other blog members have volunteered to help with legal and accounting requirements, for which I am very grateful. As noted, the Association’s main role will be to administer the funds raised by the donation widgets here and on www.keenwalk.com.au, and authorise expenditure occasionally (with the most urgent expenditures being associated with the Walk to Kosciousko in April). Otherwise we’ll continue to be the virtual community we are now.

The volume will appear too low when you hear Matt’s introduction, but this is because the audio level was set on my radio mic, which is much louder than the theatre microphone. Turn the sound up to hear Matt’s opening, but be ready to turn it down when I start talking.

I made an audio recording of the talk and the discussion as well. The audio quality in the video recording is quite good, but the audio recording is better for the discussion–at least when it comes to hearing what the questions and comments by audience members were.

Matt’s doctorate is in education, and he was fascinated by Debtwatch as an example of the way in which the internet, and blogging in particular, has transformed people’s capacity to learn. I have also found it a fascinating experience, given that I started it simply as an easier way of distributing my monthly Debtwatch Reports. I had no expectation of it becoming as big as it is now, with almost 4,000 registered users, over 7,000 unique readers per day, and a stimulating and extremely civil discussion between about 100 active participants.

Given the last point in particular, it’s been a learning experience for me as well: many of the ideas that have been discussed on the blog will find their way into the book I am slowly writing on financial instability.

I also gave a quite detailed presentation on my analysis of the financial crisis, which I’ll post when I have time next week.

The Debtwatch Association Meeting

We now have about a dozen takers for this meeting, but the more that can make it the better. So if you are able to join us for dinner at 7pm next Tuesday (March 9) in Sydney, please drop me an email using debunking at gmail dot com.

Donations have totalled over A$10,000 so far, and while I had thought this raised no income liability for me, I have been informed that it could be regarded as income by taxation authorities. Forming an Association to manage the funds will overcome this difficulty.

A minimum of 5 people are needed to form an Association, and given the model rules for Associations that we will adopt on the night, I need 7 or more people join me for dinner one evening next week. We will adopt the model rules, and also simple rules for the Association (mainly to support my research into financial instability), elect office bearers, etc.

I’d like to make this an enjoyable event, so I’ll book a cheap but good restaurant in inner city Sydney for the occasion. I hope to start at about 6.30pm and have it all finalised by 8pm (including having dinner). I will make it either Monday, Tuesday or Wednesday evening next week (March 8, 9 or 10) depending on which is most convenient for the largest number. I hope those who attend enjoy putting faces to the names they’ve seen regularly on the blog.

Could Sydney-based blog members therefore please email me at my usual address (debunking at gmail dot com) if you are able to come along on one or more of those nights? I’ll then let you know via return email what restaurant we’ll use, and on which date. We need to elect at least the following office bearers for its Committee–a president (yes I’ll stand for that election!), a vice president, a treasurer, a secretary and three ordinary members–so also please consider which role you’d like to take.

I am a great non-fan of meetings–I reckon they are where work doesn’t get done–so I hope we will keep formal meetings to the bare minimum, which is one meeting per year. The laws governing Associations in NSW are laid out here by the Office of Fair Trading.

Last week I took part in a debate entitled “The Great Residential Housing Debate – the next Bubble or a legitimate Boom?” at the annual conference for Perennial Investment Partners; I put the Bubble case and Chris Joye of Rismark International presented the Boom case (here is my paper and my presentation). As is well-known, Australia is one of the few countries in the OECD not to experience two quarters or more of falling GDP as a result of the GFC, and probably the only country that has not experienced a fall in its property market.

The conference was held twice, firstly in Melbourne on Wednesday February 24th, and then in Sydney on Friday 26th. There were roughly 400 people in the audience on both occasions, all of whom were customers of Perennial–with the majority (roughly 75%) being financial planners. The conference employed an electronic voting mechanism that let participants answer general questions, as well as rate the speakers. In our debate, it was used to work out where people stood on the “Bubble vs Boom” spectrum both before and after the debate. A “1″ indicated a complete Bear who expected property to crash and advised getting out now, while a “10″ was a complete Bull who advised “Buy, Buy, Buy”.

Prior to our debate in Melbourne, the average score was 4.9. This surprised me, because I expected the audience to be generally pro-property; however a score of below 5.5 indicated that overall the audience was bearish on property (since the average of the ten numbers from 1 to 10 is 5.5; also see ** below).

After our debate, the score was 5.2–a small move in favour of the bullish position, but still slightly in the bearish camp. Chris commented that this was “about even” and “too close to call” as he left the stage, which I thought was a fair enough summary of the outcome.

So I was stunned when Crikey asked me to respond to the report Chris had given them of the Melbourne debate (“Reflections on Cage Match Mk 1“), which included the statements that:

So I think I pretty comprehensively monstered Steve Keen at our debate in Melbourne yesterday. That was certainly the feedback from those who attended (there were 500)…

While I felt I was able to intellectually tear Steve apart limb-by-limb, I will say this: he is a lovely guy. Very diplomatic and humble in defeat…; and

Unfortunately, the electronic scoring in yesterday’s debate was a bit convoluted: it measured the shift in the audience sentiment from bearish (Steve) to bullish (Chris) before and after the event. On that basis, I won. But I think a simpler Chris versus Steve voting system would have made the difference much more striking…

Huh? The rest of the post was of a similar vein–though there were occasional caveats such as “As I noted in my presentation, Steve has made some valid criticisms of conventional economics, and its neglect of debt capital market imperfections. And he deserves some kudos for anticipating a credit crisis” (gee, thanks!), even this was immediately followed by “But whatever strengths he possesses are overwhelmed by his propensity to make silly statements.”

I had no intention of commenting on the debate prior to seeing this hit a national news site, but of course this couldn’t be ignored–though at the same time it didn’t deserve to be taken seriously. So I took a facetious approach–opening my reply with “I don’t know what Chris consumed after our talk at Perennial’s conference yesterday, but if he has any spare I’d like to try it at a party tomorrow night”, and concluding with the advice to Chris that, “Next time, after a conference, don’t consume anything, just take a cold shower”  (I also pointed out the statistical fact Chris apparently missed, that the middle point in scores from 1 to 10 is not 5, but 5.5).

Chris took this rejoinder very well–despite our fundamental differences over this issue, we get on well personally, and unlike some participants in this debate, he does have a sense of humour.

And so we proceeded to Sydney. There the audience was slightly less bearish than in Melbourne: the average score prior to the debate was 5.3, just slightly below the neutral level. But after the debate, there was a significant shift towards the Bear case. The post debate score was 4.6.

Chris had made the classic mistake of declaring victory at half-time, only to get a cold shower with the full-time result (see below however under **).

Why Debt-Deflation Causes Depressions

“Declaring victory at half-time” is a syndrome which afflicts the entire debate over our current economic situation: optimists are of the opinion that the crisis is all over now, while pessimists think it’s only just begun. On this front, as always, I regard history as the best indicator of who may be right. On this front, I can’t commend highly enough the site New from 1930, which from January 1 2009 began publishing summaries of the Wall Street Journal from January 1 1930. The last few entries include these pearls of wisdom from February 1931:

An Old-Timer believes the market rally “will do more to restore prosperity than anything else.” Total security values have increased over $20B since start of year; barring another dive in the market, this assures a recovery since the 10M-15M US owners of stock feel richer. Bulls say the ease with which considerable profit-taking has been absorbed recently is “the surest indication of a strong healthy market.” Market has rallied very substantially; “if it runs true to form, it will have one of those ‘healthy reactions’ that will, according to the bulls, strengthen its ‘technical position.’” “The buying power of the people and the corporations still is large … In other words, the country never was in a better position to stage a comeback after a depression … (Feb. 25th)

One banker cites plenty of evidence that the backlog of consuming power is largest its been in years: corp. inventories are down 20% from a year ago, and even more from 2 years ago; corps. are holding more cash; production of many products is below requirements; products have been wearing out for 18 months of deferred buying; security values up $20B since Jan. 1; easy credit; record-breaking savings deposits. Last year there were few rallies on which to sell; this year there have been few dips on which to buy. Public interest has grown this year, but is still small compared to 1928 and 1929; “a market with a growing public interest is a dangerous market to sell short.” (Feb. 26th)

Yeah, right: in both 1930 and 1931, the belief was widespread–at least in the financial community–that the Depression was over, and recovery was just around the corner. As Australia’s Alan Kohler noted when he first discovered this blog, at least early on during the Great Depression, people didn’t realise that they were in it. They too, were declaring victory at what turned out to be not even half-time.

Ultimately, the debate over whether we’re in a complete recovery or merely a temporary recess from the GFC will only be resolved by time. But well-informed theory can also give a guide as to what we can expect, and here I regard Hyman Minsky’s Financial Instability Hypothesis and Irving Fisher’s Debt Deflation Theory of Great Depressions as the outstanding guides. However they are complex theories, especially when most economists have been mis-educated by neoclassical economics into ignoring money, debt, and disequilibrium dynamics. So the following numerical example might make it easier to understand their arguments:

• Imagine a country with a nominal GDP of $1,000 billion, which is growing at 10% per annum (real output is growing at 4% p.a. and inflation is 6% p.a.);
• It also has an aggregate private debt level of $1,250 billion which is growing at 20% p.a., so that private debt increases by $250 billion that year;
• Ignoring for the moment the contribution from government deficit spending, total spending in that economy for that year–on all markets, both commodities and assets–is therefore $1,250 billion. 80% of this is financed by incomes (GDP) and 20% is financed by increased debt;
• One year later, the GDP has grown by 10% to $1,100 billion;
• Now imagine that debt stabilises at $1,500 billion, so that the change in debt that year is zero;
• Then total spending in the economy is $1,100 billion, consisting of $1.1 trillion of income-financed spending and no debt-financed spending;
• This is $150 billion less than the previous year;
• Stabilisation of debt levels thus causes a 12% fall in nominal aggregate demand.

What about if debt doesn’t actually stabilise, but instead grows at the same rate as GDP? Then we get the following situation:

• In the first year, total demand is $1,250 billion, consisting of $1,000 billion in income and $250 billion in increased debt;
• In the second year, total demand is also $1,250 billion, consisting of $1,100 billion in income and $150 billion in increased debt;
• Nominal aggregate demand is therefore constant;
• But after inflation, real aggregate demand will have contracted by 6%.

This is the real danger posed by debt: once debt becomes a significant fraction of GDP, and its growth rate substantially exceeds that of GDP, the economy will suffer a recession even if the debt to GDP ratio merely stabilises.

A debt-dependent economy has no choice but to record rising levels of debt to GDP every year to avoid a recession. Unfortunately, this makes a debt-servicing crisis inevitable at some point, especially when a large fraction of the increase in debt is financing Ponzi-speculation on asset prices, since this adds to debt without increasing society’s capacity to finance that debt.

That is why falling debt levels caused the Great Depression, as Irving Fisher argued back in 1933, and the phenomenon is obvious in the empirical data. The next few charts illustrate this argument.

Private debt and GDP levels in the USA from 1920 to 1940:

The change in private debt, added to GDP to show aggregate demand as the sum of GDP plus the change in debt:

Now I calculate the proportion of aggregate demand that is debt-financed, by dividing the change in debt by the sum of GDP plus the change in debt: the formula for is:

The correlation of the fraction of demand that is debt financed (lagged one year since the data is end-of-year annual) with unemployment is minus 0.77.  Roughly speaking, this tells us that when the debt-financed fraction of demand rises, unemployment falls, and the correlation of these two series accounts for 77% of the change in unemployment between 1920 and 1940:

Now let’s repeat the same exercise with the data from 1990 till 2010

Private debt and GDP levels in the USA from 1990 to 2010:

The change in private debt, added to GDP to show aggregate demand as the sum of GDP plus the change in debt:

The correlation of the fraction of demand that is debt financed (unlagged since we now have quarterly data on debt) with unemployment (the correlation coefficient is now minus 0.84):

This is why debt-deflation matters, and it’s also why we are barely at the half-time mark in the GFC. Though government spending has countered the fall in debt-financed spending to some degree, that fall has only hit 40% of the level that applied during the Great Depression, even though debt levels are substantially higher (relative to GDP) than they were back then.

The numerical example given above is, by the way, not too far removed from the empirical data for both Australia and the USA prior to the GFC. In the year before the crisis, Australia’s GDP was roughly A$1.1 trillion, and the increase in debt that year was A$260 billion, which was a 17% increase on the previous year; for the USA the comparable figures were roughly US$14 trillion, a US$4.5 trillion increase in debt, and a peak rate of growth of debt of about 10% p.a.

The example also illustrates why the rate of inflation matters, and why a low rate prior to a debt crisis is a serious danger. If inflation is high when the crisis hits (say 20% p.a.) then most of the decline can be taken by a fall in the rate of consumer price inflation itself. But if the commodity inflation rate is low, then the hit will be taken by asset prices and actual output as well as by a fall in the inflation rate.

The process can be countermanded to some degree by the government running a deficit, which counteracts the fall in aggregate demand caused by private deleveraging. But the government deficit would need to be far higher than current levels to return us to prosperity if nothing is also done about the astronomical level of private debt.

With the deficits that are being contemplated today, I expect the outcome to be that the rest of the OECD will “turn Japanese” and enter a long-running, low level Depression. Actions that limit those deficits–or even worse, force countries in crisis like Greece to impose austerity measures to reduce deficits back to zero–will turn this from a drawn-out Depression into a sudden and deep one.

Of course, at the same time that economic policy makers–misled by neoclassical economics–are imposing austerity programs on national governments, they are trying to restart the private debt binge mechanism that gave us the crisis in the first place. I’ll write more on this in a future Debtwatch, but in the meantime I recommend the post on this point on Vox by Peter Boone and Simon Johnson, “The doomsday cycle“.

Why has Australia done so well?

I’ve noted previously that government policy during 2009 boosted household disposable income dramatically, and Gerard Minack of Morgan Stanley recently pointed out just how much: “household disposable income increased by 10.1% over the year to the September quarter, while labour income – the biggest component of household income and traditionally the largest swing factor – increased by just 0.4%.” (Morgan Stanley Australia Strategy and Economics, February 24, 2010: The Odd Expansion). The primary factors driving household disposable incomes higher were the government’s stimulus package (which boosted incomes by about 4%) and the RBA’s rate cuts (which added another 5% to disposable incomes).

As Gerard commented when he first publicised this outcome (Morgan Stanley, Downunder Daily October 9, 2009: Antipodean Lessons), “If that’s recession, bring it on!”: it’s unheard of for household incomes to rise during a recession, and that’s a major reason why Australia avoided a downturn last year.

But it’s not the only reason: the other one, as my numerical example above illustrates, is what happened to debt levels. In our debt-dependent economies today, a recession almost always means a fall in debt levels relative to GDP (while a Depression results from absolutely falling debt). We began that process early in 2008, only to dramatically reverse direction in 2009 so that, once again, debt was growing faster than GDP.

The key cause of this was that other government policy, the First Home Vendors Boost, which enticed Australians back into mortgage debt in droves (both First Home Buyers who actually received the Boost, and the Vendors who sold to them who took levered the extra $15-40K The Boost added to the sale price into another $100-200K for their next house purchase). This policy gave us the fastest turnaround in debt levels in our post-WWII economic history.

Note that the period prior to 1965 had as many periods of the debt to GDP ratio falling as rising–which is the sign of a cyclical but non-Ponzi economy. Then from 1965 on, the trend was for debt ratios to rise faster than GDP except during the recessions of 1973-76 and 1990-94. The period of the Howard Government involved the longest sustained period of rising private debt ever–though notably this trend for rising debt began while Keating was still PM.

Then the GFC hit virtually as Rudd came to office, and the rate of growth of private debt plunged–a similar coincidence to the one that had done the Whitlam government in decades earlier (note that the debt bubble whose bursting brought Whitlam undone had also commenced under the preceding Liberal government of Billy McMahon).

Rudd deserves no blame for the bursting of the debt bubble–as I warned since December 2005, this was inevitable and when it happened, a serious global recession would begin (because the phenomenon was global and not merely limited to Australia). But his government does deserve whatever is deserved–credit or blame–for the rapid turnaround in debt. This wouldn’t have happened without the First Home Vendors Boost, since as is illustrated below, the only source of this increase in private debt has been rising mortgage debt.

Had this trick been pulled back in the 1990s, then Rudd would have received credit for it in the long run, since it would have set off a prolonged boom as debt to GDP ratios rose for many years and gave us a strong if illusory recovery from the preceding recession.

But this is 2010: household debt has risen from under 30% to almost 100% of GDP (the RBA has recently changed its statistics on this front–two months ago the figures in D02 yielded a ratio slightly above 100%), and I simply don’t believe there’s capacity for it to continue rising. So I expect that the trend will rapidly reverse itself back into a falling private debt to GDP ratio, and the recovery this rising debt has helped engineer will evaporate.

That will leave government spending as the one prop to keep the Australian economy afloat, and it is a prop that shouldn’t be underestimated, as the next chart illustrates: though the private debt to GDP ratio turned around from falling at 5% p.a. to rising at 2% p.a. courtesy of government policy, the increase in government debt added another 3% to the mix.

The sum of changing private and government debt thus substantially boosted spending in the Australian economy in 2009–enough to stop the GFC in its tracks here. But in 2010, it is highly unlikely that the private sector will continue re-leveraging. That will leave increased government debt-financed spending as the only boost.

If the government’s contribution remains at about the level of 2009–roughly a 3% boost–and the private sector continues the deleveraging it was doing before government policy kicked in–at a rate of close to 6% p.a.–then the net outcome will still be a falling debt to GDP ratio. While that is necessary in the long term to get us out of the Ponzi cycle we have been trapped in for the last 4 decades, it will still mean pain: private sector deleveraging will outweigh government sector pump-priming.

The reason is simple: so much debt has been taken on already by the Australian private sector that its capacity to take on any more is virtually exhausted. Even as households slapped on more mortgage debt under the influence of the FHVB, other personal debt was falling (until just recently) and the business sector has been rapidly deleveraging–and even so, business debt today still exceeds the peak it reached in 1990.

So the Australian gambit out of the GFC–get back into debt as fast as possible–may soon run its course. We should then find ourselves in the same situation as in the rest of the OECD–deleveraging. The fact that we are taking the “hair of the dog” approach to a debt-hangover (get drunk again on debt the next morning) is readily apparent in this comparison of Australian and US private debt levels: Australia actually began to delever before the USA did, but just as they hit deleveraging with a vengeance, our aggregate private debt started to grow once more.

Just like the “hair of the dog” approach to getting over a hangover, it works once or twice, but not forever: the ultimate destination is DA: “Debtors Anonymous”. Australia has merely delayed its entry into the club.

**

Further reflections on the Perennial debate

Chris in part attributed doing poorly in Sydney to a couple of personal mishaps that morning prior to the debate–and he did say that he expected not to speak as well as in Melbourne before the debate in Sydney took place. That would certainly have been a factor.

One other factor may be that I developed the numerical example used in this DebtWatch Report after the Melbourne conference. That gave the Sydney audience a clearer idea of why debt-deflation matters–and why the servicing cost of debt, which Chris insists is not high, is not the main problem with a debt-driven economy.

Of course, I dispute the argument that debt servicing costs are not particularly high today. As the next chart shows, even though the RBA’s rate cuts have reduced the cost substantially from its peak, interest payments on mortgages in Australia today consume 7.5% of household disposable income. This is 1.65 times the average from 1976 till now.

Yet this “average” itself is almost as high as the debt servicing costs in 1990, when mortgage rates were an astronomical 17%–2.5 times as high as today’s rates. The primary driver behind this extreme rise in debt servicing costs is the factor Chris loves to ignore, the ratio of mortgage debt to income. This is more than five times larger today than it was in 1990 (130% of household disposable income versus 25% in 1990).

In Sydney, the audience was advised (after our debate) to make a large change to its previous number if they were persuaded one way or the other; this may have made the final swing larger in Sydney than Melbourne.

Finally, Chris later argued later that financial planners are inherently bearish on residential property, since they want to advise people to get into stocks instead. That is an argument that I would prefer to take with a grain of salt. Whether that is true or not as a general proposition, it appears that the people “Mum and Dad investors” might rely upon for advice about where to put their speculative dollars are on average telling them not to put them into residential property, which is the opposite advice to that one sees regularly in the Australian media today (sourced from commentators who clearly have no pecuniary interest in whether house prices rise or fall…).

The book, Pigs at the Trough, is launched today, and having read it I do commend it to Debtwatch readers. The preface to the book, which gives a good feeling for both its subject and its flavour, is reproduced below.

“FROM THE recession of the early 1990s until the global financial crisis of 2008, shareholders experienced almost two decades of unrestrained joy, punctuated only briefly by an Asian hiccup and burst dotcom bubble. Insatiable share price and earnings growth, coupled with billions of dollars of superannuation money, saw the Australian stock market explode.

But as good as the good times seemed, the boom was built on very shaky foundations. Generous use of debt created many paper fortunes. However, it is often said, the greater the bubble, the greater the deception — and there is little doubt that many of the fastgrowing businesses were running on bluff and bluster, rather than sustainable and honest business models.

Throughout this period of excess there were several constants: the ever-increasing trajectory of executive remuneration, coupled with a new-found love of debt and widespread use of financial engineering. While real wages for ordinary workers barely kept up with inflation, executives received lucrative share options, performance rights and short-term cash bonus payments that contained very little alignment with long-term wealth creation (except for their own).

As executive remuneration skyrocketed, Australia also witnessed insatiable growth in companies that made very little of anything of value, but instead engaged in pursuits called ‘asset origination’ or ‘asset recycling’. These companies (typically called ‘ financial engineers’) would hide the nature of their businesses among an ever-growing cloak of complexity. Their Byzantine structures and opaque financial reports allowed executives such as David Coe and Phil Green to accumulate multi-million-dollar nest eggs. When the fall eventually came, these so-called masters of the universe would be well protected.

Shareholders and creditors would not be so lucky.

The financial engineers, usually operating in the once staid, government-owned infrastructure sector, used layers of leverage and billions of dollars of shareholder capital to acquire assets and later pay income from that very capital and borrowings. The engineers — led by Babcock & Brown, Allco and MFS — would become the custodians of Australia’s most important infrastructure and tourism assets. Their inevitable death, under the weight of burgeoning debt, would bear an eerie resemblance to the endeavours of the entrepreneurs of yesteryear — household names such as Bond, Skase and Spalvins would be replaced in 2008 by a new set of faces, with names such as Coe, Groves and Green.

The ease with which founders and executives enriched themselves at shareholders’ expense will long remain a case study for the
importance of corporate governance.

Eddy Groves, the man who ran what was once the world’s largest childcare company, paid his brother-in-law millions of dollars in untendered maintenance works, while Allco directors David Coe and Gordon Fell collected tens of millions of dollars after they sold their Rubicon property business to Allco — after the sub-prime crisis had taken hold. Only days after the sale, Gordon Fell’s wife spent $27 million purchasing one of Australia’s finest homes on Sydney harbour, the asset remaining safely out of reach of Fell’s creditors and Allco’s beleaguered shareholders.

Babcock & Brown’s Phil Green and MFS’s Michael King stood by while the empires they created crumbled. Both appear to have retained extensive private fi ancial interests, often purchased with monies extracted from their companies during the glory years. But it wasn’t only the engineers who brought pain to shareholders.

The Village Roadshow troika of Robert and John Kirby and ‘surrogate brother’ Graham Burke would turn the notion of ‘ alignment’ into a furphy. The Village executives received tens of millions of dollars over a decade while their bumbling management of Australia’s largest cinema and production concern cost shareholders millions.

Telstra, once a staid, government-owned utility, would turn to a big-talking American to improve its fortunes. It took four years and many billions of dollars in lost market value for the Telstra board to realise the error of their ways.

Toll Holdings, one of Australia’s most successful companies, became a pariah, paying its already wealthy executives millions for
worthless options, right under the noses of shareholders.

Even two agribusiness companies, which sold woodchips to the Japanese, ended up being Australia’s largest (alleged) Ponzi schemes, all the while costing taxpayers billions of dollars as Collins and Pitt street farmers collected tax deductions for upfront losses on revenue that would never materialise.

This is the story of how a generation of executives, under the apparent supervision of respected non-executive directors, duped millions of Australian investors, analysts and commentators.

From the carnage comes some valuable lessons. While the likes of Allco and MFS were complex, arcane entities, their financial statements gave warnings to investors to stay well away. But they were signals that were missed or ignored by almost all investors and analysts. At the same time, the business elite, the men and women who occupy the blue-chip boardrooms of corporate Australia, did little or nothing to rein in executives.

On many occasions, nonexecutive directors were unwilling or unable to stand up to executives who enriched themselves while their companies burned. This book is not merely a tale of greed, but of the clues that can be gleaned — important evidence that all investors who manage their own wealth should always be on the lookout for before trusting their retirement savings to the care of highly paid executives and boards of directors.

Pigs at the Trough will show you how to spot the next corporate car crash — and hopefully how to avoid becoming the next casualty. Santayana once noted that those who forget history are doomed to repeat it. Unfortunately for many investors, history is too often forgotten as soon as the next bubble appears.”

As such there’s more of a focus on the reasons why I have taken the activist stand that I have on the economy than on my analysis of the economy itself. While some of this focuses on my family and educational background, it also gave me the opportunity to explain that my major motivation was the desire to rid economics of the pseudo-scientific Neoclassical nonsense that dominated economics since the early 1950s.

I can’t embed the video in this post–though I may put up another embedded version when I receive the DVD of the program from Carson–but if you’d like to watch it, please follow this link.

I’ve had some difficulties in getting the embed to work (the latest version of Wordpress seems to do something untoward to the embed code) so you may need to hit the “refresh” button before you’ll see the video below.

The show always starts with an interview between Max and his partner Stacy Herbert, reviewing the financial news of the last week. It’s entertaining, informative and provocative–if you haven’t encountered Max before, you’re in for an surprise.

The interview with Max starts at about the halfway point of the video below, and we cover the housing market, why Australia has not suffered greatly from the GFC so far, why deflation is more likely than inflation, and what the outcome is likely to be of governments attempting to deficit stimulate the economy while ignoring the level of private debt.

Permanent link to the interview.

In awarding the Prize, Edward Fullbrook, editor of the Real World Economics Review, noted that “They have been judged to be the three economists most responsible for the Global Financial Crisis. More figuratively, they are the three economists most responsible for blowing up the global economy.”

The prize was developed by the Real World Economics Review Blog in response to attempts by economists to evade responsibility for the crisis by calling it an unpredictable, “Black Swan” event. In reality, the public perception that economic theories and policies helped cause the crisis is correct.

The prize winners were determined by a poll in which over 7,500 people voted—most of whom were economists themselves from the 11,000 subscribers to the real-world economics review . Each voter could vote for a maximum of three economists. In total 18,531 votes were cast.

Fullbrook cautioned that not all economics and economists were bad. “Only ‘neoclassical’ economists caused the GFC. There are other approaches to economics that are more realistic—or at least less delusional—but these have been suppressed in universities and excluded from government policy making.”

“Some of these rebels also did what neoclassical economists falsely claimed was impossible: they foresaw the Global Financial Crisis and warned the public of its approach. In their honour, I now call for nominations for the inaugural Revere Award in Economics, named in honour of Paul Revere and his famous ride. It will be awarded to the 3 economists who saw the GFC coming, and whose work is most likely to prevent another GFC in the future.”

Dynamite Prize Citations

Alan Greenspan (5,061 votes): As Chairman of the Federal Reserve System from 1987 to 2006, Alan Greenspan both led the over expansion of money and credit that created the bubble that burst and aggressively promoted the view that financial markets are naturally efficient and in no need of regulation.

Milton Friedman (3,349 votes): Friedman propagated the delusion, through his misunderstanding of the scientific method, that an economy can be accurately modeled using counterfactual propositions about its nature. This, together with his simplistic model of money, encouraged the development of fantasy-based theories of economics and finance that facilitated the Global Financial Collapse.

Larry Summers (3,023 votes): As US Secretary of the Treasury (formerly an economist at Harvard and the World Bank), Summers worked successfully for the repeal of the Glass-Steagall Act, which since the Great Crash of 1929 had kept deposit banking separate from casino banking.  He also helped Greenspan and Wall Street torpedo efforts to regulate derivatives.

In total 18,531 votes were cast.  The vote totals for the other finalists were:

The poll was conducted by PollDaddy. Cookies were used to prevent repeat voting.

For further information and interviews email: pae_news@btinternet.com