Consequences loom for global debt binge

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When Janet Yellen (pictured), chair of the US Federal Reserve, announced that America would be raising the government interest rate it signified the end of a dramatic period of declining rates since the global financial crisis of 2007-2008.

Janet YellenIf the Great Depression of the 1930s cast worldwide doubt on the validity of capitalism, encouraging many to consider socialism or communism as preferable systems, the Great Recession, which has now lasted nearly a decade, has raised similarly pointed questions.

The engine of capitalism is the cost of capital, the interest rate. In North America, Japan and Europe that engine has for eight years ceased to function, largely because governments allowed the reckless creation of 'casino money' that inevitably led to the GFC.

Only the developing world has been behaving in anything resembling a conventional capitalist fashion, with mid-range interest rates and periods of reasonably strong economic growth.

As the period of zero rates finally starts to come to an end, the developed world, including Australia, is confronting a new problem: extremely high levels of debt. The world may have survived the era of casino money — just — but it is now facing another crisis.

Low interest rates tend to change the understanding of risk; having high debt seems to be less of a problem because the cost of servicing it is lower.

This cavalier understanding of risk has been especially evident with Australian households, which have racked up over $2 trillion in unconsolidated debt. This is 123 per cent of Australia's GDP, which is more household debt compared to the size of the country's economy than any other country in the world.

The massive appetite for debt in Australian households has been replicated across the world economy. Since the GFC, global debt has grown by over 40 per cent and is now over $200 trillion. Compared with global GDP, global debt has remained fairly stable compared with pre-GFC levels, but this indicates that the much vaunted government 'austerity measures' have had a negligible effect.

What are the likely consequences of the debt binge? One is that governments will have only limited capacity to raise rates because the relative effect of doing so will be so much greater. A return to 'normal' capitalism does not seem in prospect, and governments, including Australia's Reserve Bank, will have few options available with monetary policy.

Another implication is that, to maintain stability, it is essential to have growth in the world economy. The signs are not encouraging. When the developed world was experiencing a sustained recession, the developing world, especially China, provided the necessary growth. But China and India are slowing.

The International Monetary Fund is forecasting growth in the developed world of 4 per cent, the lowest since the financial crisis in 2008. In 2010 growth in the developed world was 7.5 per cent.

There are few signs that the developed world is about to take up the slack — despite President Barack Obama's claims claim that America has the 'strongest, most durable economy in the world' in his State of the Union Address.

The extraordinary recklessness in Western financial systems that led to the GFC has not been dealt with; indeed it is hard to see how it could have been solved. The only way to rectify the problems created by the Wall Street 'casino' was effectively to give money away. But as Japan has found for over 25 years, when debt levels get too high, even zero interest rates will not necessarily stimulate demand.

The derivatives casino is finally shrinking. It is probably the case that we no longer confront a financial crisis that nobody understands.

But it is likely that we will soon be facing a crisis that is all too familiar: too much debt and not enough growth. All eyes will again be on the health of the banks. This time, governments will have few options to provide assistance.

 


David JamesDavid James is a business journalist with a PhD in English literature. He edits Personal Super Investor.

Topic tags: David James, debt, GFC, Janet Yellen, US Federal Reserve, Great Depression, Recession


 

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Existing comments

I'm interested David in understanding the relative effect on the economy of (a) a rise in GST collections (higher rates or wider base) with (b) the imposition of an across-the-board (goods and services) import tax at a rate which would collect the same amount of tax revenue as the increase in GST. What rate of import tax would be needed to raise the same amount of revenue as or current GST? I know this question might seem a bit off topic, but the increase in Australian household debt, which is your topic, must surely be at least partly due to the appreciation of the AUD during the minerals export boom period.
Ginger Meggs | 18 January 2016


The expression 'household debt' gives the impression of paying off white goods or electronic gizmos or second cars. In fact, many of these items have reduced in price, certainly relative to income. But what really causes 'household debt' is the inflation of house prices in the major cities. The role of Wall Street has been taken over by the cartel of property developers, real estate spruikers, banks and cowardly politicians of all parties.
Frank | 19 January 2016


Nice article. But there are always things governments can do if they are brave enough to take on the powerful. Lots of people have debt and they need inflation to gradually take it away, say 5-10% a year, so the state money printers need to be stoked up. The other side of the coin to debt is money hording by the very rich and that needs to be "socialised" by focused taxation and incentives to invest in infrastructure or have it taken away. Etc Etc
Eugene | 19 January 2016


Hi David, Nice paper, but I don't think you can have it both ways. If Australia has more household debt relative to the size of its 's economy than any other state, then its appetite for debt has not 'been replicated across the world economy'
barry hindess | 19 January 2016


David, I admit to having very little knowledge about the issue. I simply understand household debt as people buying on credit or loans. Perhaps it means more than that. I'm interested in knowing whether it's across all socioeconomic groups or more confined. I can easily imagine those on low incomes needing to borrow just to keep living and those with more wealth borrowing to improve their lifestyle but what about the really wealthy? As Eugene comments, the wealthy can hoard their money and use a number of methods to increase their wealth. It seems very unfair to me that the poor have to tighten their belts when the rich just keep on accumulating more wealth.
Anna | 19 January 2016


Well, there is a very simple solution, CANCEL all household debt. Bill Mitchell's Modern Monetary Theory is worth checking out, especially his analysis of the shift to profits away from wages as a share of national income, and the resulting promotion of higher debt to working people. But, yes, looks like a crisis is looming, and our governments have failed to control the banking bingers...
Karen | 19 January 2016


Echoes of what happened here in Ireland until it all came tumbling down 7 years ago...trouble is, even as we are still crawling out from underneath the rubble (those of us who 'survived' the collapse)...there's not much evidence of what we have learned from it. We just started re-building. The older generation, especially those with moderate means were always pretty great at living within their means. They watched in bemusement as the younger generations allowed themselves sink deeper into depth....'live within your means' they said,... 'do everything possible to live within your means...'
Noelle Fitzpatrick | 20 January 2016


Dear David, I agree with your conclusion but some of the numbers are wrong: IMF forecasts were 3.6% at the time of writing; and some are very misleading, levels of debt depends on where it sits as well as considerations for "off balance sheet items such as superannuation". When we all borrow more we collectively become the banks problem. The RBA will target inflation first as that is its mandate. Alas, you are correct, with inflation and rising interest rates loans will move into arrears and then default. Governments have been worried about a much more sinister problem however, i.e. that of deflation. It will be interesting to watch and very painful to bear for some.
Luke | 20 January 2016


I give up understand economics. Perhaps as Noelle parents say: live 'within' your means, and in 70 years I have known higher interest rates even to 17%. there are ways to quieten economies down but how to do this in a global free-trade economy?
Nola Viney | 24 January 2016


It`s nice to have another read of this great article. If I can make another point at this stage, it would be to agree that the only thing governments could do 8 years go, and indeed can do now, is give money away! Amazing but true. The problem we now have is the way the money was doled out; in such a way as to guarantee bubbles and the rich getting richer. The answer has always been "helicopter money" i.e. print more notes and give them the poor. The poor ill send them and stimuli the economy and the lid can be kept on inflation through interest rates.
Eugene | 19 July 2016


David, it's not public debt that has been the main problem, but growing private household debt due to low wage growth and the unstable international financial system, that punishes the poor and rewards shonky banksters.
Wayne McMillan | 20 July 2016