Get ready for an Australian recession by 2017
from Steve Keen
For the last 25 years, Australian politicians of both Liberal and Labor hue have been able to brag that, under their stewardship, Australia has avoided a recession. Those bragging rights are about to come to an end. During the life of the next Parliament — and probably by 2017 — Australia will fall into a prolonged recession.
Whichever party is in opposition at the time will blame the incumbent, but in reality this recession has been set up by the sidestep both parties have used to avoid downturns for the past quarter century: whenever a crisis has loomed, they’ve avoided recession by encouraging the private sector to borrow and spend.
The end product of that is starkly evident in a new database on private and government debt published by the Bank of International Settlements. Australia’s most famous recession sidestep was during the GFC, when it was one of only two countries in the OECD to avoid experiencing two consecutive quarters of negative GDP growth (the other country was South Korea). Since then, the private sectors of the advanced countries have collectively de-levered, reducing their debt levels from about 170 to 160 per cent of GDP. Australia, in stark contrast, has levered up. Our private debt to GDP ratio is now more than 20 per cent higher than when the GFC began, and more than 50 per cent higher than in the USA (see Figure 1).
Figure 1: Australia has borrowed its way out of recession for the last 25 years
This credit sidestep has worked because the extra debt-financed expenditure lifted aggregate demand and income well above what it would have been in the absence of a debt binge (see Figure 2).
Figure 2: Rising debt increases demand but falling debt reduces it
Unfortunately for Australia’s next Prime Minister, there are two catches to this trick. The obvious catch is that getting that much extra demand out of credit necessarily increases debt much faster than it increases income — hence the runaway ratio of debt to GDP shown in Figure 1 — and this can’t go on forever. The less obvious one is that when debt is at stratospheric levels that apply in Australia today, total demand falls even if the debt ratio merely stabilises.
The logic is pretty simple: your spending in a year is the total of what you earn plus what you borrow, and the same maths applies to the economy as a whole.
If nominal GDP grows this year at the 2.8 per cent rate it has averaged for the last five years, then GDP in 2016 will be roughly $1,634 billion. If private debt continues to grow at its average rate of 6.9 per cent per year, it will reach $3,414 billion — an increase of $220 billion over the year. Total private sector demand (which is spent on both goods and services and asset purchases) will be $1,855 billion.
What about 2017, if private debt grows at the same rate as GDP itself, so that the debt ratio stabilises? Then GDP will be $1,680bn, and private debt will rise from $3,414bn to $3,509bn — an increase of just $96bn over the year (compared to $220bn the year before). The sum of the two will be $1,775bn — 4.3 per cent less than the year before.
This is the inevitable debt crunch coming Australia’s way, but conventional economists are oblivious to this danger because they’ve brainwashed themselves to ignore private debt as just a “pure redistribution”, to quote Ben Bernanke. This deluded textbook thinking is why Bernanke didn’t see the GFC coming.
The day of reckoning can be delayed by encouraging yet more private borrowing, which the RBA can attempt to do by cutting interest rates, and the government can reduce the crunch by running a large budget deficit. But these are likely to happen after a crisis rather than before it, because our Reserve Bank and our politicians are as oblivious to the dangers of private debt today as Bernanke was back in 2007.
The 2016 election could be a good one to lose.