It's time public and policymakers refocus on and rein in private sector debt instead of worrying about public debt which amounts to little more than a neo-con scare campaign. Economist Philip Soos explains.
CONTRARY TO the concerns about government delivering numerous budget deficits, it is the growth and acceleration of private debt we, alongside policymakers, should be worried about — not public debt, which amounts to little more than a neo-con scare campaign. This is because private debt drives asset price inflation (bubbles). These bubbles always burst, causing economic destruction and financial disruption.
Just ask the Americans, Irish or Japanese. Yet, all we hear from the Coalition and ALP is the need to transition the budget back to surplus as this represents “fiscal responsibility”, while treating private debt as a no-go zone. Why? Because Australia’s household sector is the most indebted in the world and nobody wants the value of their homes and investment properties to sink.
In the real world, public debt tends to spike in reaction to economic downturns generated by financial instability and deflating asset bubbles (and historically during the two world wars). In other words, public debt is the buffer and lifeline that enables a government to absorb a wealth of economic pain in times of need.
A graph showing unconsolidated gross private debt to GDP ratios in Australia. Image: LF Economics
The private sector debt accounts are composed of three subsectors: household, non-financial business and non-banking financial, such as when a property developer takes out a loan from a bank. They are in gross, unconsolidated terms, meaning intra-sector debts are not netted out as one entity does not guarantee the debts of another.
In contrast, public debt is consolidated because the federal government guarantees the debts it holds of others. As of the third quarter of 2015, Australian public debt was by internaional standards a low 38% of GDP while private debt reached a staggering ratio of 279%. Households were 123%, non-financial business (83%) and non-banking financial (73%).
There is some evidence to suggest public and household debt undermines economic growth once it reaches a threshold of 85%, and 90% for the non-financial business sector. More recent analysis suggests there is no particular threshold for public debt. Unfortunately, Australia’s household sector surpassed that long ago, with non-financial business debt closing in.
There is no publicly available data on the long-term trends in public debt, requiring it to be constructed from a variety of sources. I suspect the reason it has not been made openly available by government is because it would demonstrate the hysteria about the “budget emergency”, “record deficit” and so on is blatantly false. Public debt peaked in 1932 at 173% of GDP, when the economy was far less productive. Today, it is low compared to historical trends.
A graph showing how public debt has fallen over the long-term as a percentage of GDP. Image: LF Economics
Probably the most accurate measure of the public debt burden is to compare net interest payments to GDP and revenue. In 2015, net interest payments were 0.7% to GDP and 2.9% to revenue; well within the margins of safety. Lower interest rates have translated into lower net interest payments.
Both public sector surpluses and current account deficits (CADs) draw demand out of the private sector; the only way it can grow is through deficits, via increased indebtedness and reduced savings (the sectorial accounting approach). This explains why private debt exploded under the Howard government with ten out of twelve budgets producing a surplus, combined with persistent CADs. This was terrible economic management.
A graph showing federal government net interest payment ratios 1971-2015. Image: LF Economics
Given the long-term data shows public debt to be at record lows, why is there so much debate about reducing the public debt? After all, former treasurer Joe Hockey admitted there was no budget emergency. Instead, the government has fabricated panic over public debt because:
- It distracts from the threat of the massive private sector debt boom, financialisation and the housing bubble;
- Privatisation is put forward as a solution to reduce public debt;
- To prevent government from funding infrastructure efficiently, given borrowing costs and fees are significantly lower than that of the private sector;
- It provides a pretext for austerity; and
- It ensures government has room to ramp up public debt to fund a future bailout of Australia’s highly leveraged banking system.
Australia should follow the example of Germany, one of the few developed nations to avoid a housing bubble by keeping its private debt issuance under control.
It has much lower debt to GDP ratios in each of its three private subsectors of around 54% to 70%, with public debt at a higher 80% with a current account surplus. A more sensible approach is for government to engage in moderate and persistent deficits of around 3% of GDP, as has occurred in most years since federation, which allows the private sector to accumulate net assets rather than maximise leverage.
In this regard, it is critical the public and policymakers refocus on and rein in exponentially-growing private sector debts as this comprises a major source of future financial instability. Ironically, by ignoring private debt expansion which has generated a housing bubble, public debt will inevitably rise to stimulate the economy to counteract the economic downturn when it bursts. This is what we should be paying attention to.
Philip Soos is the co-author of Bubble Economics: Australian Land Speculation 1830-2013 and co-founder of LF Economics. You can follow Philip on Twitter @PhilipSoos.
This article originally appeared in The Guardian and is republished with the author's permission.
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Australia has high levels of household debt. But public debt? Among the lowest in the OECD. That's us in red. pic.twitter.com/375mIqdwW1
— Mr Denmore (@MrDenmore) January 22, 2015
