Steve Keen's Debtwatch

Both parties will make much of their economic management credentials in this election campaign.

Many Australians, on the other hand, seem convinced that the economy would do as well regardless of which party were in power.

The average punter has it right: luck, rather than skill, has determined which governments in retrospect came up smelling like roses in the economic management stakes, and which instead smelt like manure.

By far the biggest determinant of political luck is what was happening to private debt while any given government was in power. If debt was rising, then the government looked good; if it was falling, then the government looked bad.

How come? Because there are two ways in which you can finance spending: you can either earn the money, or you can borrow it. Your total spending in any one year is thus the sum of your income plus the change in your debt. The crucial issue is how you spend that borrowed money: if it is being consumed or gambled, then you will come to grief; if instead you are investing in a business, or successfully speculating on shares or houses, then you can pay your debt off and end up much wealthier than when you started.

The same spending equation applies at the national level, so that aggregate demand is the sum of GDP plus the change in total debt. But the conditions under which an increase in debt can be for the good are more restrictive for the nation than the individual. The country can gain if the borrowing finances investment, but not if it finances speculation.

Investment–building new knowledge, new factories, new houses–increases the country’s income-generating capacity. Speculation–gambling on the prices of shares and houses–just changes who owns what within the country; it doesn’t add to aggregate income at all. Borrowing for speculation can be good for the individual speculator who sells on a rising market, but ultimately it just drives the country as a whole deeper into debt.

However, in the game of politics, that economic distinction doesn’t matter: a speculative dollar spent boosts demand just as much as an investment dollar. If you happen to come to power when a speculative borrowing binge is on, then you can look like a miracle worker, simply by “Being There” at the right time. Woe betide you, however, if you take over power just before a binge comes to an end.

This pattern is remarkably obvious in these two graphs: the first plots the actual debt to GDP ratio, the second plots the annual change in the ratio. When the ratio was rising faster than trend, the incumbent government won plaudits for great economic management; when it was falling, the government was “economically incompetent”, and normally lost office.

On that front, Whitlam headed the unluckiest government in our history. He came to power after the Liberals had been in power for 23 years, during which time debt was benign for the first sixteen years, and then began to rise in the last eight–making the economy look better than it was. The speculative bubble really took off a year before the 1972 election, and just six months later, it burst (see Chart Two).

(I am unable to load graphics right now, so click here for the PDF which has the graphs)

Aggregate demand took a six percent hit, unemployment exploded from under two to almost six percent (see Chart Four), and Whitlam went down in history as the worst economic manager ever.

Fraser took over when the worst of the plunge in debt was over, and Australia’s long-term debt bubble returned to trend. His government won plaudits as responsible if unexciting economic managers, as they muddled through the stagflationary period after 1975.

Fraser lost office to Hawke just before the bubble accelerated once more, and the 1980s boom took hold. Hawke proclaimed Keating the “world’s greatest treasurer” as the likes of Bond and Skase borrowed their way into economic power and apparent wealth–only for the house of cards to collapse in 1990.

Then, Hewson really did lose the unloseable election: Keating hung on to power even though falling debt was slicing almost 4 percent off aggregate spending.

By the time a more credible leader was in command of the Liberal Party, and the electorate was duly armed with a baseball bat, Keating lost power. Debt was once again bubbling along, and it became the good fortune of John Howard to ride the longest sustained upward trend in debt in our history–letting him take the credit for “good economic management” as private debt reached unprecedented levels.

What is likely to happen after the current electoral contest? I don’t believe that “business as usual”–borrowing our way to illusory prosperity–is possible any more. We enter the 2007 election with the highest level of private debt in the nation’s history–twice what applied during the Great Depression, and one and a half times the previous record, which was set during the Melbourne Land Boom and Bust of the 1880s-90s (see Chart Three).

While it might continue growing for a while, there’s no chance that it can continue growing forever. The debt ratio is four times what it was when Whitlam won office, and credit stress is breaking out around the globe as well. Debt will eventually go into reverse, demand will fall sharply–and the incumbent government will be accused of being a “bad economic manager”.

In reality, ever since the long term debt bubble began in 1964, the economic management of both parties has been “bad”: without being aware of it, they have ridden the coat-tails of speculators into office and out of it again, all the while letting the economy become ever more dependent on debt and speculation.

If we fall into a debt-driven downturn after this election, it will not be the fault of the encumbent’s policies at the time–whether it is a Rudd Labor or a Costello Liberal government–but the fault of fifty years of allowing speculation to determine both economic policy and economic performance. That is a fault shared across the political spectrum.