Australia's Debt-Fuelled Party Is About To Produce The Hangover From Hell
Debt: it’s a four-letter word.
And it usually carries ominous connotations, such as profligacy, living beyond your means, lack of discipline and, ultimately, bankruptcy.
But debt’s personality has a good side, too. It allows businesses and consumers to make sensible, long-run investments: like buying new technology and equipment, buying a home or a car, or advancing your education.
At the macroeconomic level, we need new debt all the time to ensure that spending power keeps up with our output.
So like most things in life, debt is good… in moderation. And as Australia plunges into a coronavirus recession (likely the sharpest downturn we’ve ever experienced), we’d better start preparing for the very big mountain of debt that is about to start piling up.
Unfortunately, Australia enters this downturn with a lot of debt already on the books. Households presently owe debts worth almost 200 percent of their disposable income. In other words, they’d need every single dollar of income for two long years to pay off their debts. We have the second highest personal debt burden of any of the 43 countries tracked by the Bank for International Settlements (topped only by Switzerland).
Australia’s big banks were happy to keep lending, so long as they believed we could pay it back -- with interest, of course. That long debt-fuelled party, however, produced a painful hangover. Cheap household credit was the hot air that inflated property prices in most major cities over the last decade.
That made home-owners look like millionaires -- but only on paper. It put home ownership out of reach for a growing share of younger and even middle-aged Australians. And it created a huge debt overhang that could easily threaten the stability of our financial system, if the overall economy deteriorated (as it’s doing now).
Ironically, that debt-fuelled bubble occurred right under the noses of austerity-minded politicians who warned endlessly of the supposed dangers of government debt.
They essentially advanced an Animal Farm theory of debt. Instead of "Four legs good, two legs bad," the government’s adage became: ‘Private debt good, public debt bad.’ And despite their stated commitment to balance the budget, they never did it. Australian public debt has grown every year since 2008. It was supposed to be balanced this year: a promise that went out the window with the bushfires, and now coronavirus.
At any rate, the old assumption that governments shouldn’t borrow, but private households and businesses should, was never valid. After all, government is essentially the only borrower in society that can’t go bankrupt. It pays lower interest rates than any other borrower (currently below the rate of inflation, which means real interest rates are actually negative). And it has unmatched powers to manage debt: including the power to tax, to issue currency, and to employ. When debt is used to fund investments and services that make people better off, it’s as sensible as a business borrowing to finance new capital equipment.
Get ready to see some awfully big government debt numbers in the months and years ahead. The economy is going to shrink: perhaps by 10 percent this year (our worst one-year downturn in history). That means government revenues automatically shrink, too. And government spending will grow: on existing income support programs, on special measures for unemployed workers, and on helping the health care system respond to the pandemic.
No-one these days, not even arch-conservatives, calls for smaller government anymore. We need government to protect us. And we welcome its ability to do so.
With falling revenues and rising expenses, the federal deficit this year will probably equal $150 billion or more -- twice as large, relative to GDP, as it got during the Global Financial Crisis. That sounds big, but we shouldn’t waste a single synapse worrying about it. (We have much worse things to worry about.) Within five years, total public debt could exceed 100 percent of GDP.
That’s still smaller than household debt. And it’s smaller than our public debt at the end of the second World War. No-one worried about public debt during that war. And no-one should worry about it during this one, either.
How will we ever pay it all back? The short answer is, we won’t. And we shouldn’t try. Government exists to protect Australians: including from the effects (both health and economic) of this pandemic, as much as possible. At the end of the day, large debts will be deferred, refinanced (at record-low interest rates), or converted into other assets (like money).
Already, for example, the Reserve Bank is using unconventional money-creating techniques (called "quantitative easing") to pump needed credit into the banking system. The same tools can be used to finance other priorities, including health care, essential supplies, and aggressive job-creation -- as soon as we can take off our pyjamas, leave the house, and go back to work!
The top priority now is keeping ourselves as healthy as possible, and ensuring our industries and businesses can spring back into action once the health emergency eases. It will take a whole lot of government debt to make that possible. So we might as well learn to love it.
Featured Image: Warner Bros