In the post-GFC era, more attention has been given to private credit (debt) whereas previously, almost all commentary focused upon public debt. The ruptures caused by the global financial crisis (GFC) is strongly responsible for this shift in perspective, including the research by heterodox economists. Fortunately, the mass media in Australia have done a fairly good job at bringing attention to private debt even though they are, ironically, staunch cheerleaders of inflated land prices.
As is now commonly recognised, Australia’s household sector is heavily indebted. The household debt to GDP ratio is the second-highest globally at 122%, has the second-equal highest household sector debt service ratio (DSR), and the fifth-highest debt to income ratio. In absolute terms, household debt amounts to $2.1 trillion dollars; the vast majority consists of mortgage debt with a small remainder of personal debt.
The household debt to income ratio is 172%, which is below the commonly-cited RBA ratio which registers at 190%. This is due to the different measure of debt used (the numerator). The Bank of International Settlements (BIS) only considers debt instruments in line with the UN SNA (System of National Accounts), whereas the RBA uses all household liabilities from the ABS Financial National Accounts. This is neither correct nor incorrect, just different. In compiling its debt database, the BIS must adhere to international standards.
The debt service ratio is an estimate of both aggregate principal and interest payments, using household income, debt and the average interest rate (FISIM-adjusted) variables as inputs. The BIS notes the DSR demonstrates a strongly negative correlation between household consumption and debt, for obvious reasons.
The long-term trend in private sector debts illustrates the cycles. During the 1980s, business debts rapidly accumulated as speculation in the commercial land market grew feverishly. It peaked in 1989 and then collapsed, arguably resulting in the early 1990s recession. The same dynamic occurred in the run-up to the GFC to a lesser degree, with commercial land prices thereafter declining along with business debts. Household debt continued to power on after a short dip.
While the data suggests the debt boom and the housing bubble it has generated is historically and globally extreme, it is important to note other countries have experienced higher peaks. In Denmark, for instance, the DSR peaked at 24% in 2008, household debt to GDP peaked at 140% in 2009 and the debt to income ratio peaked at 264% in 2010. It would be naive to underestimate the federal and state governments and regulators’ willingness to implement further interventions to prevent housing prices from declining to any significant degree. The numerous interventions by the Rudd government during the GFC testifies to this.
The goal of policymakers is to extend the debt-financed housing bubble for as long as possible, especially to protect the unearned gains captured by land owners and housing markets heavily reliant on construction as with Sydney and Melbourne. One difference between Denmark and Australia is the unemployment insurance. Denmark’s vastly more generous benefits provides a significantly larger buffer to aid heavily-indebted borrowers who have lost their jobs to meet their mortgage repayments. In contrast, the unemployment benefits in Australia are tiny, which is of no assistance to households with large debts and high cost of living expenses.
Our estimates for the NSW household debt to GSP ratio is 136% (BIS-compatible) – not far off from Denmark’s record. This helps to explain that state’s incredibly high dwelling price to income and loan to income ratios. While Australia is heavily indebted (which is especially the case for NSW and VIC), Denmark, including the Netherlands at a historical second-place, suggests the impossible can be made possible. In Australia’s case, however, a renewed bout of irrational exuberance and government interventions are a prerequisite to making this happen. If this is not the case, the financial position of investors will erode further from here on in.
Yes it will. Which is why I expect the next move to be down in interest rates, sooner or later.
There is scope for this last throw of the dice to increase Australian household debt further but I remain skeptical it is possible. Denmark has a much better external position than does Australia, running large current account surpluses with zero external government debt as well.
Australia’s external position is OK for now with the current account deficit at -2% more or less, but that is during a large Chinese stimulus episode, and it is unlikely to stay so healthy as it fades. The CAD was -5% and deteriorating prior and the sovereign rating is also going to be downgraded at the same time.
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As well, Denmark is not in the EUR but it’s economy is in the EZ so it’s currency has some implicit protection from any external crisis that Australia does not have, meaning we must keep out interest rates higher and fiscal ship tighter.
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.
He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.
