Australian Debt Update

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I’ve been work­ing on the sec­ond edi­tion of Debunk­ing Eco­nom­ics for the last three months, and I’m now flat out try­ing to fin­ish the first draft by the end of March—hence the pauci­ty of posts recent­ly. How­ev­er the lat­est Aus­tralian GDP fig­ures came out this week, and this has enabled me to update the Cred­it Impulse data for Aus­tralia, which has impli­ca­tions for both employ­ment and asset prices—and espe­cial­ly house prices.

For those unfa­mil­iar with the term, the Cred­it Impulse is the change in the change in debt, divid­ed by GDP. It plays a major role in dri­ving eco­nom­ic and asset mar­ket per­for­mance because, in our cred­it dri­ven economies, aggre­gate demand is the sum of income plus the change in debt. Con­se­quent­ly, the change in aggre­gate demand is the sum of the change in income plus the accel­er­a­tion of debt.

There­fore, a con­stant lev­el of aggre­gate demand requires con­stant­ly ris­ing GDP—which is unlike­ly in itself—and con­stant accel­er­at­ing debt. The only rate of accel­er­a­tion for which this is pos­si­ble is zero: debt (in real terms) would have to remain con­stant for con­stant growth in aggre­gate demand to be pos­si­ble.

Since instead debt growth is volatile, the econ­o­my is nec­es­sar­i­ly cycli­cal: a peri­od of accel­er­at­ing debt must be fol­lowed at some stage by decel­er­at­ing debt—otherwise debt would become infi­nite­ly larg­er than GDP.

A large part of why Aus­tralia got through the GFC so well—so far—is that gov­ern­ment pol­i­cy encour­aged the Cred­it Impulse here to stop falling and turn around far ear­li­er than occurred in the USA.

If this rela­tion­ship is a bit dif­fi­cult to grasp, the com­par­i­son of debt-financed demand makes it clear­er: where­as the US was hit by seri­ous delever­ag­ing, Aus­tralia stopped just shy of delever­ag­ing and then relev­ered its way back to a debt-financed pros­per­i­ty.

The debt-dri­ven boost to aggre­gate demand was the major rea­son that we sailed through the GFC. The role of the FHVB in moti­vat­ing this is obvi­ous when one com­pares the trend in mort­gage debt before it to what hap­pened after: there was an effec­tive turn­around of over 8% of GDP, pump­ing an addi­tion­al $100 bil­lion into the econ­o­my. It also meant that while US mort­gage debt was plung­ing, ours was exploding—and of course dri­ving house prices up with it.

The most recent data for Aus­tralia now implies that the Chi­na boost has tak­en over this role of keep­ing the Aus­tralian econ­o­my buoy­ant, though whether this will avert a down­turn as the hous­ing sec­tor slows is a moot point: on a year­ly basis, the Cred­it Impulse has peaked and is now turn­ing back towards zero, but on quar­ter­ly basis (the bars below show change from 3 months ago every month, scaled to an annu­al rate of change), the Cred­it Impulse has been neg­a­tive for 6 of the last 9 months, but pos­i­tive for the last two months.

The rea­son is this “chang­ing of the guard” from the house­hold to the busi­ness sec­tor: where­as house­hold borrowing—motivated by the First Home Ven­dors Scheme—counterbalanced a dra­mat­i­cal­ly neg­a­tive pulse from the busi­ness sec­tor, now the busi­ness sector—motivated by exports to China—has switched from decel­er­at­ing to accel­er­at­ing debt.

That does­n’t mean that busi­ness debt is ris­ing however—just that it’s falling less rapid­ly than it was when the GFC first hit. Busi­ness debt con­tin­ues to fall rel­a­tive to GDP, and now that the FHVB is over, house­hold debt is also head­ed down (though just to con­fuse things slight­ly more, it appears to have head­ed up slight­ly in the last month).

Not only does Aus­tralia have a two-speed econ­o­my, from a Cred­it Impulse point of view, the faster half (busi­ness bor­row­ing, espe­cial­ly by the export sec­tor) is far more volatile.

The slow part that actu­al­ly got us through the GFC (the house­hold sec­tor, and espe­cial­ly mort­gage debt) is now decel­er­at­ing (though again, the next mon­th’s data might show a pos­i­tive.)

Just as the rise in mort­gage debt was what drove prices up, this decline in the cred­it impulse from mort­gage debt is the real rea­son that Aus­tralian house prices are now falling (though of course the first swal­low of the end of the house price bub­ble is not falling prices but ris­ing inven­to­ries of unsold prop­er­ties).

This is as good a place as any to knock the prop­er­ty spruik­er fur­phy that under­ly­ing demand from pop­u­la­tion growth exceed­ing dwelling con­struc­tion needs is the cause of house price ris­es in Aus­tralia, (where­as for the rest of the world they’re hap­py to blame irre­spon­si­ble lend­ing now that all the oth­er bub­bles have burst). This is the cor­re­la­tion of new lend­ing to the change in nom­i­nal house prices:

If we look at the change in mort­gage debt and change in house prices, we get the fol­low­ing pat­tern:

And the fol­low­ing cor­re­la­tions apply: it seems that changes in mort­gage debt lead changes in house prices by about 8 months to a year.

So a rea­son­able sta­tis­ti­cal case can be made that mort­gage debt and house prices are cor­re­lat­ed, and mort­gage debt leads house prices. What about the spruik­er case that pop­u­la­tion growth exceed­ing dwelling con­struc­tion is the real rea­son? Here’s the time pat­tern:

And here’s the cor­re­la­tion data: it’s the wrong sign, triv­ial in mag­ni­tude, and con­sid­er­ing leads and lags makes the cor­re­la­tion worse, not bet­ter.

So get used to it: mort­gage debt dri­ves house prices, and growth in mort­gage debt is now end­ing. The recent falls in house prices are just the begin­ning.

In the aggre­gate, Aus­trali­a’s debt ratio is now head­ed down again, after the fall was tem­porar­i­ly reversed by the FHVB.

How far this will go remains to be seen. On the his­toric record, it still has some way to go.

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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.