, , , , ,

There is an interesting piece in The Age about the problem of rising household debt: If we are so wealthy, why are we in so much debt?

The problem with the article is that it tends to conflate public and private debt.

After the Great Depression, the institution of Keynesian styled stimulus resulted in the socialisation of the burden of economic hardship. The result was higher levels of government debt — public debt. In the neoliberal reform era this socialisation of hardship went totally out of fashion.

The great advantage of socialisation of hardship was that it could be centrally directed towards public works that generate labour and productivity. The Sydney Harbour Bridge was a Great Depression public works project that added incalculably to the nation as a whole for generations to come.


The Sydney Harbour Bridge being constructed. By Grace Cossington Smith (1930)

The current economic orthodoxy tells us that the lower the level of government debt the more virtuous the ruling government. Virtuous governments are do-little laissez faire governments, one that spend money on little more than paying off their debts. The Australian Liberal government claims to thus pursue a policy of greater virtue than Labor, namely the virtue of lower government debt, one allegedly resulting from doing nothing.

Sadly, the problem is that this policy has resulted in a transfer of the hardship of debt from the public to the private sphere as this figure from a study by Philip Soos shows:


Compared to the past, the level of Australian public debt remains at an all time low. Yet the level of private debt has soared to astronomical levels.

This next graph shows that the source of the public debt is housing and mortgages:


You can see that the banks are now lending more to households than to businesses:


In the past, liquidity flowed into supporting the business sector, where it could stimulate productivity. Today it is getting caught up into an unproductive sector the economy, housing.

The trouble is that the adverse economic repercussions of total debt are far less when the burden of debt is shouldered by government to start with, since it is far less likely than the public to default. Catastrophic banking crises ensue when the public start to default en masse on their debts to the point that their cummulative effect begins to take on ever broader socio-economic consequences, and in the worst case can bring the entire banking system to its knees.

Then the only way to contain the contagion of panic that ensues is for the burden of public debt to be socialised through government intervention — bailing out failing banks. The private sector gets bailed out by the public sector. Or, as they say: “there are no libertarians in financial crises”.

The end result is that the trend towards shifting the burden of debt from the public to the private sphere is merely a way for governments to cook their books and pretend that they can claim that their government bottom line looks good as a result of their virtuous neoliberal do-little governance. It is a lie — a problem-shifting exercise of massive proportions.

Part of the problem is well described by Nouriel Roubini. Roubini was ridiculed when he predicted the subprime crisis in the US, but every one of his predictions came all-too frightfully true. In his book on the subprime crisis, Crisis Economics, Roubini tells us:

For the past half century, academic economists, Wall Street traders, and everyone in between have been led astray by fairy tales about the wonders of unregulated markets, and the limitless benefits of financial innovation. The crisis dealt a body blow to that belief system, but nothing has yet replaced it.

As we’ve made clear throughout this book, the crisis was less a function of subprime mortgages than of a subprime financial system. Thanks to everything from warped compensation structures to corrupt ratings agencies, the global financial system rotted from the inside out. The financial crisis merely ripped the sleek and shiny skin off what had become, over the years, a gangrenous mess.

The world has deluded itself into thinking that the GFC was triggered purely by grossly subprime lending practices. Instead of using it as the impetus for reform, it was swept under the rug as being a purely American problem associated with lax local lending practices.

As a result, as long as lending practices are more virtuous, we are told the problem could not possibly repeat itself. The crisis thus need not be seen as a symptom of a thoroughly pervasive global and systemic problem, but could be conveniently explained away as a simple local issue with simple local solutions of only modest relevance to the rest of the world.

The extent of this delusion is exemplified by the way in 2008, German finance minister, Peer Steinbrück declared that events taking place in America could safely be dismissed as a local American problem of little relevance to the rest of the world:

“The financial crisis is above all an American problem”, and added, “The other G7 financial ministers in continental Europe share this opinion”. But a few days later much of the European banking system effectively collapsed. ”

Quoted in Crisis Economic by Roubini

Roubini thinks that such thinking is driven by a delusion. It is a delusion driven by a childish desire to cling to the neoliberal fairy tale that The Market is a beautiful and virtuous self-regulating miracle, a perfect example of celestial harmony. Alas, the apple in the eye of neoliberals that is The Celestial Market may be rotten to the core. Something is rotten in the state of Denmark — nay, the entire world.

The problem is that the house price to annual income ratio in Sydney and Melbourne have now reached a factor close to ten. Most housing bubbles start to pop when this ratio reaches 7 to 8. Yet there are self-professed economic prophets who claim that we are on the cusp of a ten year real estate boom. If so, housing prices will reach heights beyond a ratio of 10, making Sydney and Melbourne house prices the highest relative to income in the world. It would make it impossible for people to live in these cities. Just to own even a mediocre piece of property would place enormous mortgage stress on the average Australian household. Rents too would reach impossible heights.

All this is occurring just as unemployment is rising. The mining boom is on the wane as iron ore prices go into freefall, leading mining companies to lay off workers in ever larger numbers. The Australian dollar likewise has gone into freefall. Next US Quantitative Easing will come to an end in November, thus curtailing the easy flow of credit to banks that encourages Australian home buyers to take on enormous mortgages. As the Australian dollar tanks, that in itself will further weaken the position of the banks to lend. Next as US interest rates rise at the end of US Quantitative Easing, investors will pull out of the Australian dollar and transfer funds into US dollars, once again reducing the flow of credit to Australian banks.

The result is also a huge burden to businesses. The cost of rent goes up, putting commodity prices up. There is pressure to pay workers more so they earn a living income to keep up with cost of housing.

It may not be long before there is a huge credit crunch and liquidity crisis driven by the intolerable burden of private debt accumulated in Australia. This may even lead to a massive banking crisis that brings the entire nation to its knees, and all of the private debt may need to be socialised, turning them into government debts, as failing banks are bailed out. The delusion that Australian government debt has become so big as to have reached crisis point will be exploded, as the magnitude of that debt is dwarfed by the threat of the burden of excessive private debts. Then the harsh reality of the fact that post-mining boom Australia is once again facing becoming a “banana Republic” might dawn on everyone.