Debt-onomics and the Coming Debt-ocalypse

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Steve Keen’s surprise appearance yesterday turned out to be quite a harrowing experience for any homeowners in the audience. After laying out the importance of debt in the economy, Steve analysed the Australian housing market.

The best chart was this one:

What house price crashes really look like

It shows that, adjusted for the time at which house prices peaked, the Australian housing bubble is in lockstep with house price declines in Japan… And not far behind the US. We’re on track for trouble, even if you don’t think we’ll get there.

So why is Australia suffering now and not last year and the year before?

Part of the answer, according to Keen, is that we managed to buy time with what he calls the ‘first-home vendors grant’ (because it benefitted home sellers rather than first-home buyers).

But buying time just makes the pain worse when the crash does come, especially for the first-home buyers tricked into the market by their government. The question is whether they will deserve a bailout when things turn sour.

So how much does debt really matter to an economy as a whole?

Keen seems to think it’s the unseen elephant in the room. At least the conventional economists can’t spot it. And he’s very persuasive.

You might think the world of debt-based economics is difficult or complicated. But if you’re on the side of the person consuming the information, it’s actually very intuitive. Keen has done the hard yards for you.

Think of it in terms of your own household. If you borrow money to buy a house, has your income increased in that year? If you asked your accountant, they would say no. But an economist measuring the GDP of your household would say yes – you’ve got money and spent it – that’s economic activity.

So borrowing adds to GDP. And if you separate the change in GDP out from the rest of GDP, you discover that a lot of our world’s growth has been debt funded. The last time that happened it ended badly.

Here’s another chart featured in Keen’s presentation that he kindly allowed your editor to use. It shows that aggregate private debt has a habit of raging out of control and then plummeting back to earth at precisely the moments when booms and busts are particularly severe. The Great Depression and the current economic debacle feature prominently.

Aggregate Private Debt

Australia’s worm (the blue) has turned but not yet plunged like America’s (in red).

Keeping Up Appearances

Satyajit Das spoke about much the same topic, but used sovereign debt as his measure for debt doom and gloom. The obvious link between Keen – who focused on private debt – and Das is, of course, bailouts. Each time the private sector trips, stumbles and face plants, the nanny state is there. And the nanny state has a larger balance sheet. Which means bigger solutions, but also bigger problems.

Together with their friends at the central banks, the politicians are practicing an art Das calls ‘Botox Economics’. It’s all about keeping up appearances by injecting cash into anything that shows signs of sagging.

Das’s most powerful point was about China. Using what resembled Keen’s method of separating change in debt from GDP figures, Das showed that China is in fact only growing because it is willing to incur debts that will most likely go bad. If you adjust GDP figures for a reasonable expectation of debts that will go bad, you end up with a barely growing – or even shrinking – China.

Let’s make that clearer. China’s growth is around 8%, but most of that 8% consists of spending borrowed money that will be defaulted on eventually. Sounds like America’s housing bubble based growth, right?

‘Think of yourselves as lab rats in an experiment by Ben Benrnanke, Mervin King and Mario Draghi’, Das told listeners. The Chinese communist party is lining up right behind them to have their go… if you survive that long.

Nickolai Hubble
for The Daily Reckoning Australia

Nick Hubble
Nick Hubble is a feature editor of The Daily Reckoning and editor of The Money for Life Letter. Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like. He then brought his youthful enthusiasm and energy to Port Phillip Publishing, where, instead of telling everyone about The Daily Reckoning, he started writing for it. To follow Nick's financial world view more closely you can 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.
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14 Comments on "Debt-onomics and the Coming Debt-ocalypse"

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Biker
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Meanwhile rents rise. One of our homes’ rents rose 21% in the last year. Average rise p.a. is around 9%, more than we’d anticipated when planning our retirement. Keen? Has his significant other sold _her_ home yet?
And what’s Keen’s own place worth now?

How about BFI Boy? Has his GF sold her place?

Note to NH: I’ve copied this post. Delete it and I’ll repost, ad infinitum…
Haven’t bothered recently when my comments were ‘disappeared’.

trested
Guest

Biker, you are doing well. I have been unable to get any rental increase on my investment for the last two years. Higher rates, insurance and other expenses and more vacancies.
However, I will not sell as it is part of what I consider to be a reasonably balanced portfolio.
The only thing I am light on is GOLD! But I have been working on that.

Biker
Guest
It’s that No. 1 GOLDen Rule of property, Trested: Location. The components of that rule vary slightly for rentals. Before buying or building we look for very high employment rates, very high incomes, close-to-zero rental vacancy rates, a low crime rate, and proximity to good beaches, parks and schools. We’ve never included public transport as a major factor. It may be when fuel prices rise, but we build as close as possible to services anyway… . We believe rental demand will soar, along with weekly rents. Queues are getting longer in WA… and open houses for prospective tenants sometimes garner… Read more »
Endless
Guest

This is true, rents have increased, significantly so in some areas. According to Keen’s debt analysis rents should decrease as the deleveraging continues. They haven’t yet.

John Ellison
Guest

In Australia, rents fall after unemployment rises.
Paid hours worked is falling but not yet enough for housing density to rise, to the point where rents are affected.

The economic train wreck is continuing before our eyes.

Ross
Guest

The old bosses wanted asset price inflation from which they could clip the consumption ticket for taxes til fate met up with them.

The new bosses have other ideas … http://www.bloomberg.com/news/2012-03-18/china-home-prices-fall-in-more-than-half-cities-tracked.html

Anybody else notice that Wombat Henry put his head up from his hole? Buy bonds says the guy that financialised and 4 pillarised the economy. How long would a wombat that finally got to meet his date with moral hazard last in a birdey cage on George Street?

Biker
Guest

Upset a few tenants, I see… .

But no-one has responded to _any_ of the four questions I asked in my first comment.

It’s pleasing to note my comments haven’t been deleted.
Great to see that growth in editorial maturity.

Biker
Guest
Steve Keen?!~ One skeptic described Keen’s record well, recently: “It is a revealing exercise writing down some of the claims Steve Keen has made: In 2006, Keen said we may already be in a recession. We were not. In 2006, Keen said the Australian Debt/GDP ratio would exceed 160% by 2007. It did not. In 2006, Keen said Australia will be in recession long before our Debt/GDP ratio falls. We did not go into recession. In 2008, Keen said interest rates would be at 2% by 2009, and ZERO by 2010. The interest rate trough was 3%; today rates are… Read more »
John Ellison
Guest

Biker, your non-personal questions have all been answered by Steve Keen on his web site.
“In 2008, Keen said house prices would be down 40% within ‘a few years’. They fell by about 3% in 2008 less than one-tenth of what Keen predicted, rose strongly in 2009, rose again in 2010, and have fallen by 2.8% in 2011.”
Answered by first chart above. In 2008 it was unclear which path Australia would take. Now we know the effect of the first home vendors grant.
Biker, cheap shots at the messenger do not shine a light on the serious issues we all face.

Biker
Guest

“…the serious issues we all face…” (?)

I’d have presumed that, for 30% of the Australian population, rising rents are a ‘serious issue’.

‘cheap shots’? Moi? To the contrary, I believe Australia’s Most Famous Tenant should be recognised as the Patron Saint of Landlords! :D

elke hubble
Guest

Hi,
here in Scotland families are moving in together – 3 generations in one home – means 1-2 houses empty. Resession and banks unsafe is a good way of telling people spent your money NOW. When house prices were rising and everybody was so happy about it, I could not believe it. The only winners where the banks and the goverment. Now, we have the opposite, but the winners are the same.
Mama

Biker
Guest

Yes, the UK is in major trouble, Elke. Things don’t look all that good for the whole Northern Hemisphere, in fact.

Wonder if you Scots will manage to detach from England before it actually sinks?

Davo
Guest

Biker, good to see you are still alive and kicking those housing doom and gloomers. My suburb in Brisbane has very few houses for sale at all, probably down about 40% from the boom 2009 period. Less supply and same levels of demand are seeing price increases (according to local realtors).
Unit sales are also increasing in dollar terms with regular sales over the original asking price.
All comes back to the market in which you invest in how attractive it is to potential buyers – Keen always used a broad brush approach to housing nationally, as though it’s one market.
Cheers

Biker
Guest
G’day Davo. Yes, back from four months in the US (including Alaska), Mexico and Canada. Off again soon… One great sale a year ago. Put up a kite and had three offers, two full price… and the third was first with a deposit after I explained the situation. We could probably have entertained a bidding war, but we were very happy with the sale… and its timing, tax-wise. Good rentals are going ballistic here. The more good folk believe in this ‘inevitable property crash’, the higher the rents must go… ! :D “Keen always used a broad brush approach to… Read more »
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