The obsession on both sides of politics with cutting the Federal Government deficit is not only short sighted in the context of the recovery from recent floods. It is also economically insupportable when private debt in Australia is more than twenty five times public debt.
It is hard to discern a clear reason for the obsession, beyond spruiking the virtues of thrift, or the idea that government borrowing crowds out private borrowing, or perhaps variations on the quaint old twin deficits theory that we used to hear about in the nineteen eighties.
The twin deficits theory is easy to dispose of. The claim was that a government deficit induced a (much larger) balance of payments deficit. Stephen Bell, in his 1997 book Ungoverning the Economy, plotted the two deficits from 1973 to 1994. There is no correlation whatsoever. Not that empirical falsification ever discouraged theoretical economists.
Part of the thinking behind the twin deficits theory was that government borrowing competes with private borrowing, so if the government borrows a lot it will tend to force interest rates to rise. That might make some sense if public borrowing was a large fraction of all borrowing. However economist Steve Keen has for some time been pointing out, using official data, that public borrowing is much smaller than private borrowing. Here is one of his revealing plots.
As you can see, currently public debt is around 6% of GDP. Total private debt is hovering around 160% of GDP, about 26 times bigger. Next is a breakdown of the debt:
The largest fraction of private debt is in the form of mortgages, which add up to almost 100% of GDP, whereas business debt is only around 60% of GDP.
Furthermore private debt has skyrocketed over the past decade, from around 100% of GDP to around 160% of GDP. The idea that reducing government debt by a few percent of GDP will make any difference to the economy is ludicrous in this context.
The third reason for obsessing about government debt, implied if not stated, is that thrift is a virtue. But why would thrift be urged so vociferously in this one area of Australian life when the siren call of debt is heeded by everyone, everywhere else?
The issue should not be government debt, but the use to which the debt is put. If the debt is used to build or restore infrastructure, it is a sound investment. The irony is that a great deal of the private debt is not for sound investment, but is frittered away on housing speculation and imported consumer goods. A shift to more government debt and less private debt would very likely improve investment in the productive economy.
So why do the Opposition and the mainstream commentators bang on so much about the supposed need to return the Budget to surplus? For Opposition Leader Tony Abbot it may simply be a convenient stick to thump the Government with, one that happens to act as a powerful dog whistle to the right-wing press. For those of right-wing persuasion, it may be a device to reduce Government, not just government spending. For economists of any persuasion, no credible reason seems to be evident.
Even more strange is that Labor takes the whole thing seriously, instead of just pointing out the pertinent numbers and laughing the issue out of court. However Labor runs scared on the whole issue of economic management. To take on the critics would take a little wit and a little courage. Ah, theres the rub, expecting wit or courage from a modern Labor Government, or a modern Labor Party.
The fuss should not be about government debt, it should be about dangerously high private debt. There are two related and compelling reasons for this, both of which Steve Keen and a few other lonely voices have been warning about for some time.
First, the greater part of the private debt is mortgage debt, which has increased rapidly, from about 20% to about 90% of GDP since 1990. Bankers and reserve bank bureaucrats deny there is a housing bubble in Australia, but the ratio of price to household disposable income has doubled since 1996:
The large mortgage debt will not generate any productive return. It has simply gone into inflating a housing bubble, which is the main reason for the ridiculous price of houses today. Demand may have temporarily outstripped supply (the fashionable reason) but much of the demand is for speculation, which will evaporate when prices stop increasing.
This brings us to the second and more dangerous problem with private debt, which is that we are still at risk of a major recession if the debt bubble pops. The problem is not just high debt, it is that debt has increased rapidly. In 2007 the net increase of private debt amounted to an astounding 20% of GDP. In other words the economy was not booming because of increased production but because we borrowed hundreds of billions of extra dollars. Without that increase in borrowing, the economy would have been in severe recession. We have been living beyond our means, and running up the collective credit card.
The great danger is in the fact that debt bubbles usually dont deflate slowly. The bubble is inflated by speculation and panic buying (if we dont buy now well never be able to) combined with loose lending practices. If prices start to decrease, the speculators want to bail out, which drives the price down faster, generating a vicious spiral. This happened in the United States subprime mortgage crisis, which triggered the global financial crisis.
As prices drop, available credit suddenly shrinks, so less money circulates and the economy slows. Just as the economy boomed when everyone was happily borrowing and spending, so it busts when the money supply shrinks and people reduce their discretionary spending to focus on paying down their debts.
The fact is that Australia’s economy has been grossly mismanaged by successive treasurers. The economy has prospered on a mining boom and easy credit. The proceeds of the mining boom have been frittered away on consumer goods and speculation. Too little has been invested in the productive economy. The grasshoppers summer may be coming to an end. The wisdom of the industrious ant may soon be forced upon us.