8 September 2009

Why its all uphill from here....

Steve Keen has a grip, at least. I for one am completely confident this view is right.

When Australia began its most recent descent into debt in mid-1964, the average annual increase of 4.2% in the ratio added only a trivial amount to aggregate demand—since at the time debt was a mere 25% of GDP. But at the end of the debt bubble in 2008, when debt had become 165% of GDP, that same rate of debt growth added a huge amount to demand—the economic “car” gained speed as the slope of the debt mountain increased.

We hit the bottom of that mountain in March 2008, and now we’re starting to climb out of the valley—though not yet in absolute terms, since thanks to the First Home Vendors Boost, mortgage debt is still growing as business busily delevers (see comments on the data, below). But once deleveraging takes hold, the acceleration caused by racing down Debt Mountain will be replaced by an economic car straining up the Mount Debt Reduction. This change in the terrain will constrain private economic performance until debt has fallen significantly, as it did after the 1890s and the 1930s.

A similar, if more extreme, picture applies in the USA, where private debt is now 300% of GDP. In contrast to Australia, the USA’s debt ratio began to rise as soon as WWII ended: on average, US private debt rose 2.9% faster than GDP every year until 2008, taking the debt ratio from 45% at the end of the War to 300% now. Deleveraging from this level of debt must exert a substantial break on economic performance, by diverting income from expenditure to debt reduction.

I am therefore one of a minority of economic commentators who regard “deflation and deleveraging” as the main dangers facing the global economy in the near future (curiously, this minority might include Australian Prime Minister Kevin Rudd). From my perspective, the Global Financial Crisis marks “a change in the terrain”: for decades, rising debt has turbocharged economic performance; now falling debt will be a drag on economic activity.

The vast majority of economists who perceive the GFC as a pothole on the road that is now behind us do not consider debt and deleveraging in their analysis. Their models have neither credit nor money nor private debt in them, so from their point of view, there is no terrain at all beneath the car—merely a long flat highway of history along which the economic car drives at the speed it is underlying “real” economic performance.

No comments: