Australia’s foreign debt time bomb

By Leith van Onselen

The Australian’s Adam Creighton has done a great job today outlining the risks inherent in Australia’s $1 trillion of net foreign debt, which has left Australia deeply exposed to a sudden lift in global interest rates:

Indeed, few countries should be as worried about the prospect of sharply higher global interest rates as Australia… Not many nations have accumulated $990 billion in net foreign debt like we have, equivalent to about 56 per cent of GDP, up from 8 per cent in 1995.

While many other countries’ national debt levels are far higher, few have sourced so much of theirs from foreigners. The Japanese government, the world’s most indebted, is the classic case, having borrowed almost entirely from its own citizens. Unlike Japan, Australia’s governments can’t tax foreigners more if they refuse to roll over the loans.

…a sustained rise in interest rates could be the sledgehammer that derails Australia’s Goldilocks economy. Household spending — the biggest part of economic activity, already labouring under sluggish wage growth — would suffer if mortgage repayments began to climb…

Australia’s total foreign debt, totting up those of government, households and business, totalled just under $1 trillion last year. That’s a higher ratio than Argentina or Mexico, reflecting foreigners’ confidence in the Australian economy and our ability to repay our debts.

The current level of foreign debt is roughly twice the proportion of GDP it was in the late 1980s, when ­serious people, including then treasurer Paul Keating, worried it was too high.

Keating oversaw politically painful budget surpluses for three years to try to curb our debt dependence. We haven’t had any of those for a while.

Too much foreign debt, the argument went, risked a financial and economic crisis if foreigners, for whatever reason — spooked, say, by a collapse in the price of Australia’s commodity exports — decided Australia hadn’t the economic capacity to repay.

“If it weren’t for the level of ­foreign debt, interest rates in this country would be much lower,” John Howard said in the 1996 ­election campaign he would go on to win…

According to calculations by respected economist Saul Eslake, the implied net interest rate on Australia’s current foreign debt mountain was just under 2.3 per cent last year.

About a decade ago, when foreign debt was $535bn, it was closer to 5 per cent.

Back-of-the-envelope calculations suggest a return to 5 per cent would cost more than $20bn a year in extra interest payments, money that could have gone on new cars, smartphones or kitchen renovations. Australian households are the main culprit in the foreign debt bubble, having a total credit-to-GDP ratio of 122 per cent, putting us at the top of the world rankings with the Swiss…

Warwick McKibbin, one of the country’s top macro-economists, believes rising global rates would filter through to suburban mortgage payments.

“Everything else taken as given, a change in the US long-term bond rate will eventually feed into borrowing rates here,” he told The Australian yesterday.

Australia’s extreme net foreign debt (NFD), which has been channeled through the banking system via mortgages (see below charts), is something that MB has warned about since its inception.

In fact, we recently consulted extensively to Dick Smith Fair Go’s (DSFG) latest report, entitled “Australia’s Debt: an Honest Debate”:, which covers the same issues mentioned by Creighton:

Australia’s bigger problem is private debt…

When it comes to household debt – which includes people’s mortgages, credit cards, overdrafts, and personal loans – Australian households are the second most indebted in the world (after Switzerland) when measured against the size of the economy, or Gross Domestic Product (GDP)…

Most of Australia’s $1 trillion dollars in net foreign debt has been borrowed through the banking system and used to increase home lending.

As at June 2017, the banking sector had borrowed some $850 billion from offshore, equating to 49% of Australia’s GDP.

Australia’s banks would never have experienced anywhere near the same degree of asset (loan) growth without this tapping of offshore funding markets. Accordingly, the total value of Australian home loan debt would never have grown so strongly, and Australian house prices would be materially lower as a result.

Australia’s banking system is also now so large that it is considered ‘too-big-to-fail’ by the ratings agencies, which means that the federal government (read taxpayers) would be required to bail the banks out in the event that there was a banking crisis. Accordingly, the major banks’ credit ratings are now inextricably linked to Australia’s sovereign AAA credit-rating.

The higher the rating, the safer bet you’re seen to be by lenders who will be willing to extend larger amounts at a cheaper rate of interest.

The key risk is that the banking system’s ability to continue borrowing from offshore rests with foreigners’ willingness to continue extending credit to them. This willingness will be tested in the event that Australia’s AAA sovereign credit rating is downgraded (automatically downgrading the banks’ credit ratings), if there is another global shock, or a sharp deterioration in the Australian economy (raising Australia’s riskiness as a borrower).

While Australia’s government debt is currently low, the Federal Budget is hostage to the banks’ offshore borrowing excess as it cannot borrow to spend on infrastructure or other initiatives for fear that Australia will lose its AAA credit rating, automatically downgrading the banks’ credit ratings and causing an unravelling of the private debt bubble created by the banks.

Indeed, credit ratings agency, Moody’s, last year noted that “A key issue for the Australian sovereign and the country’s banking sector is their reliance on overseas funding… This means a relatively greater vulnerability to ‘event risk’ than most other AAA – rated sovereigns”.

In a similar vein, the Murray Financial System Inquiry warned that “Australia’s banking system is highly concentrated, with the four major banks using broadly similar business models and having large offshore funding exposures… Australia is susceptible to the dislocation of international funding markets or a sudden change in international sentiment towards Australia, which would reduce access to, and increase the cost of, foreign funding [and] a severe disruption via one of these channels would have broad economic and financial consequences for Australia”.

Domestically, the build -up in private debt has been sustainable while interest rates have been at record lows.

However, loans run for 25 to 30 years. Anyone who thinks rates will stay at record lows for that length of time has their head in the sand.

There are plenty of people who’ve bought into the frenzy, borrowed to the hilt, and given themselves little room to move in the event of a rise in interest rates…

Higher loan costs would lead to less spending, which would affect employment rates, hit the government’s budget, and plunge us into a recession.

Australia’s huge external vulnerability via the build-up in non-productive private (mostly housing) debt is a ticking time bomb for the nation.

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Unconventional Economist
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  1. Debt can always be repaid at some stage if you have a productive economy and for the individual punter a Job.
    the real issue is jobs. cos if the punters go from being tax payers to dole dependents, the productivity of the whole joint goes missing like that airplane, or the FH core??

    • Seeing that the vast majority of the investment is in ‘non-productive’ assets then the debt is not going to be paid. The idea of the banks being too-big-to-fail is a joke. A collapse could be beyond anything the dull ideologue politicians respond to.

      • What % of the population actually works, and what number of that group works in anything productive? probably a scarily low number.

      • A joke it is. The US can bail out their banking system okay but we wouldn’t be able to bail out ours, despite the (relatively) low Govt debt. Our rating would go from AAA to hell in one swoop and the banks ratings would go the same way, pushing funding costs and therefore interest rates into blue heaven. It’s that circular relationship referred to above.

        Added to which, you can only imagine what our economy would look like if the banks got into that much trouble that they required a bail out: the social security bill would be off the dial by then as unemployment crashed into double figures. When you think about it, there is so much that could go wrong (and probably will). Ignorance is definitely bliss – 99% of Aussies haven’t a ‘macro’ care in the world.

    • boomengineeringMEMBER

      Lucky I missed out on that promised Teaching job for Rio at Mongolia, would have been one less individual punter that didn’t come back.(.MH 370)

      • HAng around, I’ll get this surfing thingy going, then we are on to the trans continental rail line project
        YOu have a start there
        I was going to develop the surfing thingy myself but after seeing the enthusiasm for FH and its team, that is the way I’m going with the surfing thingy, I expect it to be rolled out now by Strayan tech colleges.
        MAssive boost for the kids. but they will have to come to terms with offshore wages. its not a charity.

      • boomengineeringMEMBER

        You never did come back to me about my nephew Burt Burger ( Sunova Surfboards, Slater bought 4 full price) who invented Firewire and won International Shaper of The Year award.

        Railways? had to teach the fitters how to hand scrape for steam slide valves, hand scraped turbo alternator in my apprenticeship at BHP, also for navy in 1971 datum plate for guided missiles.

  2. As long as the debt is denominated in AUD I don’t really see the problem

    Future generations will simply pay through a lower currency and reduced purchasing power

    • Well it is a problem as without a productive economy you get poor. Perhaps that is what all the third world migration into Australia is all about. Preparing us for the new future.

    • Will the lenders agree to continue with AUD denomination in the future, i.e. when the loans need to be rolled over?

      • I guess ultimately they agree to roll over the debt in AUD or get given a whole heap of newly printed AUD to pay off the debt they won’t roll over.

      • My guess is that foreign creditors will keep rolling over as they have been doing for many decades now – and AUD has been steadily losing value against the creditors’ currencies.

        Falling AUD is necessary to regain competitiveness but the associated loss of wealth is real.

        Once Australia runs out of assets to sell, watch out.

    • Yes and no. If we print massively that will crash AUD. Crashing AUD will be necessary sooner or later to re-establish our competitiveness anyway. The negative part is that it will become cheaper for the foreign funds to buy Australian assets while the locals will be starved of their funds, so even a greater proportion of Australian assets will end up in foreign hands.

      Poverty usually does not occur with a swift stroke – it gradually creeps in. This may be a good thing so that the population can be conditioned to the new normal.

    • Jumping jack flash

      being globally competitive is so last century. All the cool kids are switching to services, paid for by debt created by debt.

      But if we insist on living in the past, then yes, crashing the dollar is probably the best option to get competitive again while saving the banks and the debt.
      It will require some CPI manipulation to hide the inflation so interest rates don’t rise. Should be a piece of cake!

    • OK as long as you are not part of the following generations I guess. Listen to the weeping and moaning (and that is NOT having a crack) from the younger folk in here who have already been sold down the river (along with the whole tradable sector)

      • Note also – if in response to the decline in your currency you don’t also reorganize your nation to a highly productive structure oriented towards favourable/surplus Current Accounts you don’t end up at some new stable lower level. You end up in a vortex going down that you can’t get out of. Viz Venezuela.

      • P.S. So the reform of your economy is still very painful with great dislocation. Only difference is that it is MORE painful causing MORE trauma and dislocation than if you’d reformed earlier.
        The devaluation of the currency in response to debt and lack of productivity and common prudence is no magic elixir that suddenly makes everything into a paradise on earth.

  3. Straya is fortunate to have a research economist as Treasurer who knows what he knows and it’s all good as long houses are transacted at ever higher prices.

    As others on this blog have said this situation has come deliberately and there is no desire to amend it, but simply pray that it doesn’t collapse.

  4. But what’s the worst that can happen? Our house that isn’t ours anyway due to the enormous mortgage on it gets taken off us, that we have a nation such as China influence our governments, that our resource profits go offshore, that we pay more for our gas than our customers overseas do? That our wages stagnate, that governments cease building infrastructure, our hospital waiting lists blow out… sounds like just another day in the life of Australia to me.

  5. Why is this not effecting the AUD? The investors overseas are not seeing this and getting scared with their money sitting over here? If the AAA rating was knocked down would that cause the investors to flee and crash the AUD?

    • Not if it’s the Japanese and Europeans funding it with their printed confetti. Beats a negative rate right?

      • Not if it’s the Japanese and Europeans funding it with their printed confetti.

        I can never quite fully understand how the Japanese confetti as a funding source. I assume that the currency somehow reflects the country’s industrial output and relative productivity. Also, the Japanese punters aren’t lining up for debt so it’s gotta go somewhere.

      • jimbo
        The Japanese run CAS. They own massive offshore assets including Treasuries and they owe their debts to themselves. So they can afford to print. We do pay them in USD. The Europeans are balanced because of one or two countries – in particular Germany. So they’ve been able to run the presses so far. Again though the printing is just putting off the day of reckoning.

  6. reusachtigeMEMBER

    LOLOLOL!!! It’s not a time bomb. It’s very productive as it has gone into property which only booms and gives massive returns!

  7. Property “only booms” Reusa is crap. – Brush up on your Australian property history.
    From 1887 to the peak in 1891, housing prices increased by 32 per cent, only to collapse by 31 per cent over the next half a decade.
    Prices remained stagnant until the early 1920s before lifting by 25 per cent, only to fall once more during the Great Depression. A doubling after WW2 when rent controls were abolished and then a downturn in the 1961 credit squeeze.
    Housing prices increased by 70 per cent from 1961 to the peak in 1974, then fell by 16 per cent to 1979 during the midst of a recession.
    House prices stumbled along for several years, and then quickly accelerated from 1996 to now.
    None so blind as those that cannot see. After every boom there is a downturn. This negates your simplistic view that property “only booms”.
    The above rough timeline mostly relates to NSW and VIC I haven’t even mentioned Perth Gladstone Port Headland, Gold Coast etc. need I add more?!

    • Preaching to the choir here, mate. All good points though.

      PS Reusa is a treasured MB resident that ensures we never lose sight of the Australian property specufestor or their unique psychology.

      • Yup, Reusa is our resident “alternative facts” guy/girl.

        and if you pet his avatar the right way, it purrs.

    • whilst the history of downturns is correct, what has changed is the importance of ever-increasing housing prices to the national lifestyle.
      Never has the economy been so dependant on increasing house prices to maintain the increasing levels of debt.
      Govt knows this and thus will pull out all stops to prevent any hic-ups. Not to mention the massive influence the bankers have over govt policy.
      It all ends in a lower standard of living for the majority,

    • “need I add more?” Nah! Just get on board with our favourite humourist who always come up with a bit of satiric gold.

  8. So why is Switzerland number one in debt/GDP? Did they spend theirs on houses and iPhones or is it just an accounting anomaly as they are a money laundering/banking/CAS country?

  9. “reflecting foreigners’ confidence in the Australian economy and our ability to repay our debts.”

    Nah!!! It reflects foreigners’ confidence that we are willing and happy to keep selling them assets to cover the debt whenever that is required.
    One TRILLION dollars in debt is one thing. There is another Trillion gone in net assets held by foreigners – including about 90% of our mining companies and resources.
    Adam Creighton AND MB greatly underestimate the seriousness of our situation. However thankfully a couple of people in the MSM are starting to get a feeling of something badly wrong.
    Now we just need somebody to ask RBA Treasury, Scomo and Shortonbrains – What is the end game they have planned?

    • Flawse,

      We have been around here for long enough, shouting the importance of CAD from the rooftop for as long as I can remember.

      The only reason the creditors are willing to hold AUD is that they want to buy Australian products and assets. And they don’t hold most of AUD in cash – they reinvest in productive assets like mines, farms, etc.

      Wonderful thing this poverty is – it is this sinking process rather than a state one is in. I hope people enjoy the sinking feeling.

  10. Of course this is going to happen – the banks are businesses.

    “Warwick McKibbin, one of the country’s top macro-economists, believes rising global rates would filter through to suburban mortgage payments.

    “Everything else taken as given, a change in the US long-term bond rate will eventually feed into borrowing rates here,” he told The Australian yesterday.

  11. Jeff Gundlach (who has an excellent record thinks US 10 year is going to 6%
    Can you imagine where asset prices will be on US 10 year yields btw 5 and 6%

  12. How much of the foreign debt is hedged via FX swaps though? Banks are pretty good at that. Turns US$ floating (vs. libor) into A$ floating (vs bbsw)

    • Kenobi
      Basically that is an automatic part of what they do. They are still basically borrowing at the A$ interest rate but have virtually unlimited funds to fill whatever demand for credit there is at the particular IR. The problems start to arise when the term of the Swap expires. If the IR’s or the currency has moved against them in the meantime it gets expensive. It doesn’t affect their Balance Sheet in A$ but it sure as hell affects the future IR and what they can then borrow in the future. Too many A$ out there and nobody wants them? Also IF the loan is to be repaid they have to have A$ – IR’s go up OR the RBA prints. If the RBA prints then the currency can go to hell in a wooden hand cart very quickly.
      Our solution has been to mop up the surplus A$ by selling assets to foreigners. Great solution!!!