The AFR has a nice little exclusive today from S&P:
Australia’s household debt levels are among the highest in the developed world, adding urgency to the federal government’s achievement of its surplus pledge, warns the Standard & Poor’s analyst charged with keeping watch over our AAA credit rating.
“It’s only really been in the last four years that Australia’s household savings rate has been rising,” analyst Kyran Curry told The Australian Financial Review from London.
“[High household debt] creates a vulnerability because if there is a downturn in the labour market and people start losing their jobs, then given the banks’ exposure to households it could create problems if we see a lot higher levels of non-performing loans.”
Final budget outcomes released for the 2012 financial year this week that showed the government’s quest to achieve surplus to be on track were “an endorsement” of the plans, Mr Curry said.
I’ll just add that clarifying where S&P sees the Budget headed this year would have been useful. Is it the $25 billion deficit they told the ABC? The $15 billion deficit implied by their recent analysis. Or the surplus they mysteriously endorsed following the release of the first two forecasts?
Still, there is one thing here that we should take notice of and it is this: S&P is telling only half the story. If we have high household debt and we must have a surplus to offset it – that is, protect creditors through government guarantees – then how do we grow if we’re also running a current account deficit?
A quick reference to Delusional Economics and his grasp of sectoral balances helps. Here are the dynamics he describes for Europe:
The basic premise of European policy is to tighten government budgets in an effort to drive down deficits. In the absence of a current account surplus in order to maintain a level of national income this requires an expansion of private sector balance sheets (ie through adding debt). If this does not occur then the most likely outcome is a slowing of internal demand and therefore a slowing of imports. This in turn should drive the balance of trade towards positive territory, but at the same time lower overall GDP.
Falling GDP leads to falling national income, which in the absence of real across the board wage deflation means more unemployment and therefore slowing government revenues which, as I’ve said previously, leads to a self-defeating process of re-newed cuts to government budgets.
So in essence this whole process becomes a struggle between the balance of the external sector, real wages and unemployment and this is the dynamic we have been witnessing in much of the periphery over the last 18 months. What I have noticed recently is that the adjustments in periphery nations balance of trade has been seen by some as a sign of recovery, which in part it is, but ultimately what is required is a sustained current account surplus.
So long as the mining boom has been running, it has been possible to expand the (non-household) private sector balance sheet (through debt and equity) as the public sector aims to shrink its balance sheet without hitting growth too hard.
But as the mining boom ends, we will face only three ways of expanding private sector balance sheets (and to keep growing in the presence of a public surplus). Either exports must rise (which will happen some but not enough), productivity must rise (which will happen some but not enough) or we must take on more debt (this time in households again, especially if the dollar remains high).
In other words, the S&P prescription of a Budget surplus virtually guarantees the worsening of the problem it is designed to ameliorate.
The banks themselves can see the fallout of this coming, from Banking Day:
Banks in Australia will not be able to increase the proportion of their funding from foreign wholesale sources if they are to satisfy the demands of credit ratings agencies and regulators, NAB’s finance director Mark Joiner indicated yesterday.
“I regard us as at a peak in wholesale borrowing, not even in percentage terms but in dollar terms,” Joiner said at a Committee for Economic Development of Australia lunch in Melbourne.
“Australian banks will only be able to grow in line with what they are able to bring in on the customer side (with deposits).
“So they will not be able to go with an upswing in credit.”
”In my view, the Australian banks, for a long time, will only be able to buy the asset side of their balance sheet dollar for dollar with what they bring in on the customer side,” he said.
Joiner said that if banks were to borrow more offshore to cater to a rise in lending demand ”the regulators will start to get more assertive” while ratings agencies may consider downgrading them.
”We already have one shot across the bows from the ratings agencies and we’ve been downgraded from AA to AA-,” Joiner said.
That is, it may not even be possible to expand household balance sheets to grow, even with government guarantees.
The post-GFC failure to recalibrate Australia’s macro-economic settings, relying instead on some nebulous Chinese put to keep the mining boom going, is going to catch up to us. Either we need to break the nexus between interest rates and the dollar so we can stimulate export demand but not credit demand, break the nexus between interest rates and credit growth so we can lower rates and the dollar without increasing household debt, or break the nexus between the Budget and bank balance sheets so we can start running public deficits as the private sector deleverages. And preferably all three.
