It goes without saying that I’m a Cassandra amongst the Pollyannas crowing about Australia’s current economic performance data. Low inflation, low unemployment, and no sign of a wages breakout, are the usually-quoted sweet economic indicators (admittedly with some strange bedfellows, including a relatively slow rate of economic growth for these conditions, and a huge balance of trade deficit despite the best terms of trade in history).
So how do I justify the stance of a Cassandra? Because things can’t continue as normal, when normal involves an unsustainable trend in debt. At some point, there has to be a break–though timing when that break will occur is next to impossible, especially so when it depends in part on individual decisions to borrow.
However, it is possible to quantify the minimum impact that the end of the unsustainable might have on the economy: what would happen to aggregate spending if private debt grew no faster than GDP?
Aggregate spending–on both commodities and assets–is the sum of incomes plus the increase in debt. Using GDP as the measure of income, this was $1,001 billion in the last calendar year. Over the same period, private debt increased by $202 billion. Aggregate spending was thus approximately $1,200 billion. Private debt grew by 14.9 per cent in the last year, versus a 7.4 per cent growth in nominal GDP.
If both private debt and nominal GDP were to grow at the same rate as GDP last year, then GDP next year would be $1,075 billion, while debt would rise by $115 billion. Aggregate spending would thus be $1,190 billion–or $10 billion less than spending this calendar year.
In one sense, we are now so much in debt that we can’t afford not to continue borrowing. And yet the more we do borrow, the more severe the shock will be to aggregate demand when the correction finally occurs.
This situation has come about because of the exponential growth in debt relative to GDP. Back in 1963, when debt was just 25 per cent of GDP, a fall in the rate of growth of debt had only a minor impact on demand. Now, with debt equivalent to 153 per cent, that small effect has become a very big one.
So my Cassandric pessimism is not entirely based simply on disposition. At some point, the debt to GDP ratio must stabilise–and on past trends, it won’t stop simply at stabilising. When that inevitable reversal of the unsustainable occurs, we will have a recession.
Just the Facts, Ma’am…
To be continued after I finish this morning’s lecture… In the meantime, for most of the charts that will appear in this report, please go to the Charts page of this blog.
