Australia ‘s economic performance during the Howard Years has been as paradoxical as a platypus. Like the platypus, with its duck’s bill on a mammal’s body, and reptile eggs popping out where there should be babies, contradictory economic phenomena abound in Howard’s Australia.
For all but its first budget, the Government has achieved large surpluses. Conventional wisdom suggests that government surpluses slow the economy down, yet the economy has been booming for a decade.
That’s the beneficent half of the Platypus; the malevolent is the international paradox of buoyant commodity prices and a huge balance of trade deficit. China’s voracious demand for raw materials has made it a golden time for our commodity exports, and our terms of trade (the ratio of export prices to import prices) have risen from 89 when Howard came to power, to 122 at the end of 2005. Such buoyant conditions should have meant at least a balanced current account (the difference between exports and imports), if not a surplus. Instead, at almost 6½ per cent of GDP, the trade deficit is the biggest in our history.
How can we reconcile deflationary government policy with a booming economy, and stellar export prices with a record current account deficit? Is there something truly new about our monotreme economy, or are we being deceived?
The answer, unfortunately, is deception: the hidden trick that glues the platypus together is debt. Behind the appearance of fiscal austerity on the one hand, and a miracle economy on the other, has been a dangerous addiction to credit. Australians have borrowed their way to illusory prosperity.
Thanks to Sean Leahy
Nominal GDP has risen from $515 billion when Howard came to power to $935 billion in 2005an impressive 82% increase in ten years. But that’s nothing on the 306% increase in mortgage debt across the same period! Mortgage debt rose from $170 billion in 1996 to $700 billion in 2005an increase of $530 billion, fully 25 per cent more than the increase in GDP. Household borrowing has therefore financed more than half the increase in spending since the advent of the Howard government. That debt-financed spending has more than counteracted the deflationary impact of ten successive Government surpluses.
Rather than our current account deficit forcing us to borrow to cover the difference between exports and imports, we have borrowed first, and financed a speculative and consumer binge with the proceeds.
From this perspective, though the latest Costello budget continues the populist irresponsibility of its predecessors, its impact may be substantially different. In previous budgets, each dollar in tax cuts was matched by another ten borrowed by households to finance speculative purchases of housingin the mistaken belief that this constituted investing for the future. The credit was readily supplied by our deregulated financial system, with much of it raised overseas, causing our foreign debt to blow out from $190 billion to an appalling $450 billion on Peter Costello’s watch.
Now that the party has ended (at least on the eastern seaboard), all we have to show for it is overvalued houses, a plethora of plasma TV screens, and a hangover in the form of accumulated debt. With house prices now falling, there is some prospect that this year’s tax refund largesse could be directed towards debt repayment rather than further speculation.
However, the structure of the cuts mitigates against this in favour of the foolish tendencies of the past decade. With the biggest cuts going to very high income earners ($150,000 p.a. and above), it is quite possible that the extra dollars could reignite a housing bubble at the upper end of the property marketor finance leveraged speculation on the now clearly overvalued stock exchange. Either response would give the far more responsible Reserve Bank little choice but to increase interest rates once more, despite the fact that this would hurt middle income earners far more than they have been helped by Costello’s latest handouts.
Thus, though Australia’s economy appears to have been well-managed by the Howard Government, it has instead grown on an all too expensive diet of borrowed money.
Would an ALP government have done any better, however? On the long term evidence, I doubt it. Figure 1 shows the ratio of total credit (the sum of mortgage debt, personal loans and business debt) to GDP from 1953 till 2005. This ratio has quite literally grown exponentially, at a rate of 3.5 per cent per annum, through Liberal and Labor administrationsthough the growth began in the mid-60s rather than earlier, and there have been clear periods of acceleration under the Whitlam, Hawke/Keating and now Howard/Costello governments. The trend indicates that, at a fundamental economic level, the policies of our chief political rivals are Tweedledum and Tweedledee, and that the economic system rules the government, rather than the other way round.
In the past, the trend to ever-increasing debt has re-asserted itself after a short, sharp downturn (in 1975 and 1990); it cannot do so again this time because the debt to output ratio is so much higher. Ultimately, debt must be serviced out of income, and we cannot service a debt ratio of 250% (the level it would reach if this trend continued till 2024) at any rate of interest. The consequences of government inaction to stop this would be dire, with a currency freefall likely.
The good times of the relaxed and comfortable decade must be followed by a far less sanguine reckoning with the debt collector; the only question is when, not if. When the reckoning arrives, it will not be a short interlude of sobriety before the next party, but a long period of detox to wean the Australian economy off its addiction to debt. This has not been a Platypus Economy at all, but one drunk and deluded duck.
- There is no easy, quick fix to the predicament of excessive debt. Like a cartoon character that has stepped off a cliff, the answer to the question What do I do now? is You hit the ground. The policy changes that are needed are not simply revisions to macroeconomic settingsinterest rates, government surpluses, etc.but significant shifts in Australian institutions and attitudes.
- As Hyman Minsky put it, the best policy is to build a ‘good financial society’ in which the tendency by businesses and bankers to engage in speculative finance is constrained. Deregulation has clearly failed here, as credit standards have been eroded by lenders competing to fund Australia’s favourite speculative activity, real estate. Smaller deposits have been allowed, larger income multiples used, multiple income earners counted, all ostensibly to enable greater access to home ownership; but the aggregate outcome has been inflated property pricesbacked by inflated levels of debt. We need to restore credit standards in lending, by regulation where feasible, and by making lenders carry the risk of lax lending where not.
- The concept that Mum and Dad investors should decide where Australia’s capital is invested was woolly-headed to begin with. The onus on investment decisions has to be shifted from householdswho have predictably equated investment with buy real estateto business.
- House pricesespecially in Sydney and Melbournehave to stagnate or fall until a sustainable parity is restored between the cost of housing and median income levels. RBA Governor Ian McFarlane’s jawboning on thiseven his suggestion that young people move away from Sydneyis entirely appropriate.
Pain cannot be avoided. There has to be an extended period in which debtespecially household debtgrows more slowly than the economy. Inevitably that will mean slower growth, and certainly a lower rate of growth in consumption.