Thursday, February 11, 2010

Australia's Debt

With all of the kerfuffle about debt this week, it's important to realise what debt we're talking about when using the word.

Broadly there is private debt and public (govt) debt. Both of these types of debt can be domestic or foreign.

To be clear, Australia has a low level of public debt when compared to most other developed countries, but private debt is extremely high. Indeed, Australia is more (privately) indebted than it has ever been in its history.

The two other occasions when debt has been high have been before the 1890s and 1930s depressions. The 1890s revealed how external developments could exacerbate domestic economic problems. During the 1880s, servicing Australia’s debt increased from 15 to 40 per cent of export earnings. And when the British bank Barings nearly went bankrupt through bad deals in Argentina, British investors did the sort of wholesale reassessment of developing country investments that has been common in recent years at times of crisis. The substantial decline in the demand and price of commodities, and the decline in foreign sources of capital, intensified the problems caused by over-expansion in the wool industry, property speculation (especially in Melbourne), banking collapse and over-investment by colonial governments in infrastructure.

Public debt during the Great Depression of the 1930s was high – about 128 per cent of GDP – because of government efforts to develop the economy through the provision of infrastructure and support. Rolling over debt was no longer possible after the crash of 1929 and debt servicing as a percentage of export grew steadily during the 1920s, reaching a peak of 50 per cent in 1931 and remaining over 30 per cent for most of the 1930s.

Foreign debt was a major policy concern of the late 1980s and early 1990s. It seems, however, that concern about debt has lessened as the debt has risen and it has risen almost continuously from the mid-1970s (see graph).

Foreign Debt
Percentage of GDP

Australian General Government Sector Net Debt

Australia’s major problem is with private debt, although public debt is also increasing due to government efforts to stimulate the economy. After reaching a high of 18.5 per cent of GDP in 1995–96, Australia’s general government net debt fell markedly to a net surplus in 2005–06. Continuous growth and a sustained resources boom can do wonders for a government’s fiscal position, but given the revenue that the boom created, greater efforts could have been committed to build up of a true counter-cyclical budget surplus ready for use during a downturn. The political difficulty of such a task should not, however, be under-estimated. The problem is that a growing surplus tends to be accompanied by assertions that the government should limit future revenue by returning surpluses through tax cuts. Governments also fear that if they build up a surplus, oppositions will be able to make electorally popular spending promises. Nevertheless, Norway managed to legislate with cross-party agreement in 1990 for the creation of a sovereign wealth fund to invest surpluses from its resource wealth so that when the oil revenue runs out Norwegians will continue to reap the benefits of resource abundance. Astute public management of national wealth during the good times will enable Norway to deal more effectively with future vulnerabilities. Throughout the world, public debt is increasing, but some countries are clearly in better positions than others.

Australia’s public debt position is reasonably sound, but this is not the case for many other countries, including the world’s two largest economies – the United States and Japan. And it's certainly not the case for the PIIGS. The Greek situation is very very serious. While much of Japan’s public debt is taken up within Japan, this may not be possible if debt continues to expand. The huge government debt of the United States will soak up a considerable of amount of global capital, but the United States has the advantage that its debt is denominated in its own currency, which means that any fall in the value of the greenback diminishes the size of its debt.

While the Howard government pared back net government debt to positive territory, private debt increased significantly. Both political parties now appear to accept the ‘consenting adults’ view of foreign debt – the idea that as long as debt is between private businesses with the aim of creating economic activity it should not be a concern of government policy. Those who are concerned about the increase of debt worry that it has not gone into creating the productive capacity that will earn the foreign exchange to eventually lower the level of debt. The persistent warning of analysts that high foreign debt left Australia ‘vulnerable to a change in global financial market sentiment’ will be tested over the coming years. The main variable here is the danger of self-reinforcing movements of sentiment. If Australia’s foreign debt is seen as a problem by those who fund the debt then it will be a problem.
A major factor in the growth of foreign debt in Australia and the corresponding deterioration in the CAD has come through the huge expansion of household debt, much of which has gone into housing. This has helped to make Australia one of the dearest places in the world to buy a house. Debt has been expanding almost continuously since the early 1960s to levels never-before-seen in Australian history. Particularly noteworthy, as the graph below shows all too clearly, is the almost continuous expansion of debt as a percentage of disposable income since the early 1990s recession. At its peak in December 2007, debt reached 160 per cent of income. How this debt unwinds over the coming years will matter a lot to Australian households. After falling slightly in late 2008, debt rose again in mid-2009. Like so many good things in life, increased access to credit is a double-edged sword. Credit and debt are, of course, two sides of the same coin. Once again the question is how high debt can go as a percentage of income.

Household Debt to Disposable Income

Interest Payments to Disposable Income

The second graph shows the percentage of disposable income spent on interest payments. Despite interest rates reaching unprecedented levels in the late 1980s, interest payments as a percentage of disposable were much higher in the 2000s. The Reserve Bank’s 4.25 per cent reduction in interest rates over late 2008 and early 2009 acted to substantially reduce interest payments. Now that interest rates are once again on the rise, interest payments as a percentage of income will also increase. 

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