Posted: July 10, 2005

Debt climbs and retail slows!

In Saturday's Sydney Morning Herald article Decade of debt eats family cash by Matt Wade, finally we see some mainstream interest in the household debt problem currently facing Australia. However, the analysis by the journalist fails to correctly locate the problem fairly and squarely in the Federal Government's misguided budget surplus obssession.

The article is in fact a summary of the latest Deutsche Bank's financial obligations ratio, which provides a comparative assessment of the shifts in financial stress over time by country. Wade says that "A decade-long borrowing binge has left Australian families with more financial obligations than their US counterparts." He goes on to say that in the mid-1980s, Australian households used 11 per cent of their disposable income to service nominal financial commitments (debt repayments, rents, council rates and insurance premiums). The latest DB financial obligations ratio show this grab is now 18.6 per cent (the US ratio is 18.5 per cent). The US ratio has remained roughly constant shifting from a steady 16 per cent of household income in the 1980s to over 18 per cent in budget surplus years of Clinton.

The rapid rise in the Australian financial obligations ratio shows that the threat of bankruptcy for Australian households is now higher than ever before. Our debt ratio is now 160 per cent of household income, doubling in the last 10 years. Our debt burden is considerably higher than for the US, Canada, Japan and New Zealand.

Wade claims that the "growth in household debt has been driven by property prices - which have doubled nationally in less than 10 years - low interest rates and the easier availability of credit." However, he fails to mention the fiscal squeeze that the successive budget surpluses have put on the private sector in Australia. It is a matter of accounting that the government surplus equates dollar-for-dollar with the non-government deficit. Within the non-government sector, the private domestic sector, particularly households have been borrowing heavily from the foreign non-government sector (the huge current account deficits have provided the finance for the accumulation of AUD financial assets by foreigners). The only way the economy has continued to grow with the net contribution from the government sector being negative is through the increased leverage of the domestic private sector.

This is a short-run growth strategy and eventually runs the risk of creating the conditions for a sustained recession. As soon as the private sector (households and firms) begin to realise how precarious their balance sheets are, they will attempt restructuring through saving. Then the fiscal drag will reveal itself as a strongly negative component of growth. This precariousness has also changed the conduct of monetary policy. The Reserve Bank has been reluctant to push interest rates up because it knows the economy will quickly meltdown. Wade reports a commentator from DB who says "The sharp rise in household debt has increased the exposure of the Australian household sector to interest rate changes and virtually ensures that any monetary tightening by the RBA will be modest relative to history."

The factors that might trigger a change in behaviour by households all spell trouble for the economy. If housing prices fall households may find themselves facing negative equity conditions. If saving rises, it is almost certain that unemployment will rise and households may be then forced to liquidate their asset positions, further worsening the slowing housing market. But the debt defaults that will follow will quickly multiply throughout the economy. The news today that several large retailers have revised their profit forecasts down as their sales outlook worsens reinforces the danger the economy is in. Pity we do not hear any noises from Canberra that they will reverse their budgetary strategy.

The problem then is that the budget drag has stopped the economy from producing enough jobs to reach full employment and hence we have suffered from persistently high unemployment (five percent unemployment is not full employment!). But the budget surplus strategy has also created the conditions in the private household sector where unsustainable debt holdings will eventually trigger a saving reversal (increase) and then the unemployment situation will worsen quickly.

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