Australian Debt – The Deleveraging Has Not Even Begun

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While global leaders (we use the term very loosely) gather in the trendy French town of Cannes to ruminate on the myriad problems caused by too much debt, Aussie banks are still reaping the benefits of an increasing Australian debt.

Over the past week or so, NAB, Westpac and ANZ have all reported record annual earnings. The Commonwealth Bank, with a June 30 reporting date, delivered a $6.8 billion cash profit a few months ago.

How do the banks continue to make such healthy profits in the face of the weakening economy? Aren’t households saving income at the highest rate in decades and paying down debt?

Well, you would be forgiven for thinking this way. But a quick glance at the balance sheets of the big four banks (and data from the Reserve Bank) suggests anything but.

The process of deleveraging Australian debt has not even started yet.

According to statistics from the RBA, in the year to September 2011, seasonally adjusted total credit outstanding (which is a measure of total debt in the economy) was $2.03 trillion. At the end of June, Australia’s economic output was $1.31 trillion, putting the total debt-to-GDP ratio at around 155 per cent.

A year ago, total debt outstanding was $1.97 trillion. And the year before that, $1.92 trillion. No evidence of deleveraging there.

And if you look at the big banks, they are continuing to grow their assets. Banks’ assets are equal to the debts of households and businesses. So if their assets are growing, so too is debt. Banks make a profit margin on every dollar of asset growth they enjoy, so higher assets mean higher profits.

In the year to June 30, the Commonwealth Bank’s assets grew 3.3 per cent to $668 billion. The other banks that rule off the books at the end of September also expanded. Westpac grew assets 3.4 per cent to $628 billion.

The ‘smaller’ two of the big four – NAB and ANZ – appear to be sacrificing profitability for growth. They expanded their asset base by a sizable 10 per cent and 12 per cent respectively.

On average, the big four grew assets faster than the overall market. This indicates the majors continue to grow at the expense of smaller competitors. The concentration of financial power in Australia is ongoing.

What about Australian housing debt? In aggregate, that’s not being paid off either. In the two years to 30 September, owner-occupier housing debt has increased from $740 billion to $846 billion. Investor housing debt has increased from $316 billion to $360 billion.

So if you’ve been thinking that Australia’s high savings ratio, which hit 10.5 per cent in the June quarter, is going towards paying down debt, you’d be wrong. In fact Australia has been doing the opposite. Australian debt levels continue to grow.

The savings rate may be a little misleading too. According to the Australian Bureau of Statistics:

Household saving is not measured directly. It is calculated as a residual item by deducting Household final consumption expenditure from Household net disposable income. As the difference between the two aggregates is relatively small, caution should be exercised in interpreting the Household saving ratio in recent years, because major components of household income and expenditure may be subject to significant revisions.

Anyway, the point we’re making here is that Australia’s period of deleveraging, unlike the rest of the Western world, has not yet begun

That could change soon though. China’s economy and demand for raw materials is beginning to slow noticeably. Steel inventories are building. Those with a penchant for wishful thinking are not worried. They believe the central planners will be able to ‘finetune’ the economy and prevent a hard landing.

They ignore all lessons of history. They even ignore an event that has hardly passed into the history books – the US sub-prime crisis. Once a credit bubble pops, it’s all but impossible to reinflate.

The China slowdown will hit Australia’s terms of trade and national income. The RBA can offset this to some extent through interest rate cuts. But it may be the catalyst that forces Australia to join the rest of the developed world in the process of deleveraging.

In the meantime, expect uncertainty and more volatility. As Murray Dawes says in his just released YouTube Stock Market Update, ‘everything is now set up perfectly to see the markets fall over in the near future’.

Here we go again.

Greg Canavan
for The Daily Reckoning Australia

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Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.
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6 Comments on "Australian Debt – The Deleveraging Has Not Even Begun"

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Chris
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Greg,

Thank you very much for your article. It is this type of analysis that every financial commentator should be undertaking. Too often it’s the same generalities that are presented like savings increasing. You have shown that such savings are not being used to pay down debt. And debt keeps on climbing. Very good points for concerned people to keep in mind.

Rick W
Guest
Australia is missing the opportunity of a generation to undertake orderly deleveraging. Instead we have the RBA sending the wrong signals – punish savers and reward debtors. Australia is destined to follow the same path to the economic abyss as Greece is now teetering on. Already this week I have had two new credit card offers and another to increase the limit on an existing card that never gets near the limit and is repaid fully each month. A little well-directed debt can make an economy hum but, when it is misdirected and force fed in grotesque amounts toward speculative… Read more »
Ross
Guest

Here’s the offshore market’s vote of confidence in the backbone of the Australian economy…

http://www.bloomberg.com/news/2011-11-03/genworth-profit-declines-65-on-investment-loss-to-sell-australian-stake.html

Ross
Guest

And risk off in the AUD bond markets http://www.bloomberg.com/news/2011-11-03/kangaroo-bond-sales-slump-as-basis-swap-signals-rebound-australia-credit.html

Spare a thought for the suckers stuck with senior unsecured Australian bank debt as covered bonds look like getting flogged up to 25% of their new book; it’s not just the depositors and the taxman getting subordinated.

Patrick Donnelly
Guest

As delevaraging begins in America, this is a very slo-mo depression crash, a lot of Aussie assets will come onto the market! And the European PTW, powers that were!

Expect prices to be tempting!

Suddenly, Australia will find it has oodles of capital and at good earnings too!

Keep the valuations low lads and Gail!

AnnoyingO
Guest

It is hard to predict what will happen to Australia, but our record real estate prices sure set us up for a big fall.

Hard to know what is going on with China.

And yet the unexpected could happen. Perhaps overseas investment money will be forced here while we are still looking good, further inflating our asset prices?

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