Condemning ourselves to the Eureopean doom loop

By David Llewellyn-Smith

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.

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Comments

  1. Jumping jack flash

    “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).”

    This is an excellent analysis.

    Surely we must be all princesses!

    Due to our reluctance to get productive and competitive, the solution to the private debt problem is to simply take on more private debt to grow the credit economy?

    Oh I can see this working a treat…

  2. I regard us as at a peak in wholesale borrowing

    So, peak debt too in Oz perhaps?

    Australian banks will only be able to grow in line with what they are able to bring in on the customer side (with deposits)

    Then let’s hope you keep paying us a decent return on our savings (4.5%+). If we end up with ZIRP and low bank savings rates, I and many other may start using Mattress Bank.

      • Taking the long view of the RBA’s chart pack, with household debt having essentially flatlined at circa 150% since the GFC, I’d be somewhat inclined to call peak household debt too.

    • There was a story on mattress bank yesterday saying boomers are doing that already and the reason was the missing currency in circulation. a big call as it might also be crime.

      • wasnt this in regards to pensioners keeping huge sums of cash on hand, to qualify for more of the pension ?

        apparently there are more $100 notes in circulation now, than there are $20 bills…

        • Yes because of the ludicrously low limit put on liquid assets in the pension means test. i.e. Pensioners are stashing $100 bills rather than putting them on deposit where Centrelink can see them.

          Wouldn’t be surprised if this behaviour also starts to increase amongst younger people when unemployment expectations rise (given ludicrous policy that you have to burn through practically all liquid assets before accessing UE benefits).

  3. “if banks were to borrow more offshore to cater to a rise in lending demand, the regulators will start to get more assertive”

    Hmmm. A bit too late for the regulators to get up from the nap at the wheel, but maybe better to be late than never!

  4. The simple answer to your question is that we continue to sell our assets to foreign buyers at an accelerated rate.

    1. “Either exports must rise (which will happen some but not enough),” Why will the VALUE of exports rise within any foreseeable time frame? You have drastically lower prices for mining production, you have a basically anti-business environment, the economy, and all major govt spending, is wholly oriented to restoring consumption not production.

    2.”productivity must rise (which will happen some but not enough)” Yes productivity must rise but the ‘which will happen soon enough’ is baloney. I guess it depends on the definition of productivity. At the moment if we employ a lawyer whose job is specifically to put laws into place to inhibit future production we get an increase in productivity!!!!! For crying out b….y loud. It really is time to redefine productivity.

    So, in this country, we have an anti-business environment, Govt surpluses are to be achieved mainly through increased imposts on business (That Idiot Swan’s definition of ‘saving’)

    Note from “Links” this article should be read and digested
    Rebalancing the Economy in Response to Fiscal Consolidation – Liberty Street Economics – New York Fed

    3. “or we must take on more debt (this time in households again, especially if the dollar remains high).” Sort of! Our solution so far is to sell national assets. I cannot see a single reason why this will not be our main economic weapon for the immediate future. This is the favoured solution by the RBA, Treasury, Govt of every political persuasion, Academic economists, MSM, even the seemingly intelligent media like MacroBusiness. So it is the only real alternative.

    4. “then how do we grow if we’re also running a current account deficit?”

    I’ll ask again…why do we HAVE to run a CAD. A CAD is an outcome NOT an input. A CAD involves selling assets or borrowing more foreign funds. Why do you make it a GOAL in your analysis?
    I DO understand that balancing the Current Account will require short-term downward pressure on GDP…maybe LOTS of it!

    • “Our solution so far is to sell national assets. I cannot see a single reason why this will not be our main economic weapon for the immediate future. This is the favoured solution by the RBA, Treasury, Govt of every political persuasion…”

      Indeed. Herein encapsulated a key reason why I despise with a visceral loathing every single one of our politicians, with the notable exception of those “nuts” like Barnaby Joyce and Bob Katter; yes, those awful bush whacker rednecks who have the unmitigated gall to want to keep Australia Australian, and have the spine and cojones to resist the tide of treason masquerading as “being-a-good-global-citizen”.

    • Isn’t the pre-condition to all of these possible course of events in Australia the rate of growth in the US and Europe ? As long as US growth is tracking along around 2% and even lower in Europe, it’s hard to see interest rates moving up in those countries. Given that background, the nexus between the rate differential and the AUD still exists – even if the RBA does move rates down here – which will no doubt continue to provide support to the AUD at levels that don’t necessarily make our exports any more competitive. So where does the export growth come from ?

      Yield is king out there at the moment, and there are plenty of instos worldwide still making the case that Australian banks are still fairly valued at their current multiples, and those 7% yields still sustainable even if there is no earnings growth. I can’t see those flow of funds being pulled out from under the banks while global growth looks poorly.

      And which political party is going to champion or defend a policy of achieving lower GDP growth (even if it isn’t explicity stated)? For the time being they have all snookered themselves into ideological or populist corners.

      I think at the margins the ‘best’ that will happen in the short term is some loosening in industrial relations, but you can’t help but feel that it won’t be until the punters been waking up to higher unemployment and lower house prices for some time that the penny will drop, and enable a political party to mount a platform of substantial structural change.

      • “but you can’t help but feel that it won’t be until the punters been waking up to higher unemployment and lower house prices for some time that the penny will drop, and enable a political party to mount a platform of substantial structural change.”

        Good summary pith
        When TSHTF it won’t be ‘our’ fault. There will be Union campaigns on TV etc distorting the truth (as usual) Nothing will be our fault…it will be the ‘Guvment’ or the bosses or Gina et al. IWe’ll have wealth confiscation, Gold confiscation etc etc….you can see what’s coming in the pages of MB.

        It’s impossible to talk sense in the Australian environment.
        So my outlook is probably somewhat more pessimistic than yours!

        • I think it will remain difficult to have those ‘sensible’ discussions while there are those extreme cases of income disparity – executives on multi-million dollar salaries while their workforce accepts redundancies and lower pay deals, parliamentarians voting themselves wage increases. And banks continuing to book ever increasing profits does tend to add to the cognitive dissonance many households will be feeling. The cultural change has to be across the board – there does need to be a sense of a common challenge whose burden is being shared. Banks, for mine, have drawn a line underneath an unsustainable level of profitability, with the government’s tacit approval, and the market not willing to look a gift horse in the mouth. Maybe the alternative would precipitate a less manageable scenario. But it doesn’t make it easy to talk ‘sense’ to people who feel they are being asked to accept a lower standard of living which doesn’t feel like it is being equally shared, even if their own expectations also feed the problem. T’was ever thus, huh ?

          • Yes but as you indicate the income inequalities are now just monstrous. And the less you actually produce the more you get paid it seems viz Bankers Lawyers et al
            Agree you can’t blame the average poor b…..r.

            Sigh!

          • The income and overall wealth disparity is a huge problem. It destroys any sense of being in this together.

    • It isn’t a goal its a limitation enforced on us by surplus countries prepared to manipulate their currencies over the long term.

      Unless we join them in lowering the $A (which I think we should b the way even though inflation will be an outcome in the short term) then the only alternative is DRAMATICALLY lower consumption to equalise our investment spend with our domestic savings.

      Much lower consumption inevitably equals much much higher levels of unemployment as many of the industries that channel consumption are also large employers (retail, hospitality and leisure).

  5. P.S Sorry re productivity “(which will happen some but not enough)” I misquoted HnH. Nevertheless my objection remains. As long as the economy remains short term GDP growth only oriented,REAL productivity will decline.

    • Did you miss the shot across the bow from ASIC about the possibility of their banning short selling * cough * bank shares * cough * again?

      • Banning short selling while allowing margin lending (again)?

        I did not know till today that ASIC’s job was to destroy the integrity of the system. Time to abolish ASIC as a part of the efficiency dividents.

    • I think it is safe to say that most MB readers have “under-weight” the financial / banking sector in the last 24 months. I don’t think the yield play compensates the risk assumed.

  6. so we can stimulate export demand

    Forgive what may appear a silly question. But one has to ask, HOW do you stimulate export demand, unless you either dig up, build, or grow something that others actually want and are able to buy?

    Further, even if you can achieve this, how do you attain sufficient financial benefit from those export sales, when the sectors generating those sales are increasingly sold off to / owned by multinationals and SOE’s?

    • HOW do you stimulate export demand, unless you either dig up, build, or grow something that others actually want and are able to buy?

      Currency manipulation but this will not be sustainable in the long-term because the other nations will do the same and creates currency war which won’t benefit anybody.

  7. “Condemning ourselves to the Eureopean doom loop”

    Yep Op8…Our past profligacy condemns us….we are already doomed! It’s just a matter of time and how we precipitate the inevitable.

    The answers lie back in time!

    • The easy answers lie back in time.

      There are answers and solutions but none of them are politically acceptable and they all involve pain.

  8. Yes Jack I’ve been through that one before and adapted the change to easy. Even up to the HARD answers lie back in time. The only ones available are the extremely hard, massive dislocation types. As you point out we won’t do that!

    So I’ve just gone back to the concise version!

  9. We’ll re-run the late 80’s only this time it’ll be Chinese tourists touring the reef and croc adventures and sell off the Gold Coast to them at high prices (buying it back when it crashes)or perhaps the Guvment could buy Caterpillar or Sany (since thats about all we need here) and supply all the worlds mines with equipment.

  10. Seems every country/region in the world wants to improve competitiveness to grow their way out of problems by increasing exports.

    Australia. Southern Europe. US. China. Etc.

    They can’t all do it. One country’s increase in exports is another country’s increase in imports.

  11. Seems every country/region in the world wants to improve competitiveness so they can get out of trouble by increasing exports.

    Southern Europe. Australia. US. China. Etc.

    They can’t all do it. One countrys exports are another’s imports.

    Someone will just have to recognise the demand ain’t there.

    • Duh!
      So we should just continue to over-consume much more than we produce while at the same time continue to sell off all our national assets and industries to the US or UK with their printed paper or to China, again, in exchange for US printed bits of paper?

    • They can’t all do it. One countrys exports are another’s imports.

      Not everybody exports the same thing.

  12. One way to possibly “break the nexus between interest rates and credit growth” would be for RBA to act in concert with APRA and Treasury. RBA could drop rates while APRA could do its job and jump over the exobirant lending habits of banks. Meanwhile, Treasury could cut the pipeline of tax deductions (as recommended by the Ken Henry Twigs and Leaves Taxreview) that makes its way to property speculators who still seem to think RE prices should increase by multiples of incomes year in, year out.