Not long ago you wrote that, “An official interest rate of just 6.75 per cent would inflict as much pain as 17 per cent did back in 1990.” We’re now talking about 7.25 per cent. Why is the impact so much greater today?
Because the level of debt is so much greater than it was.There are two factors that determine the burden on your bank balance: one is the interest rate level, the other is the amount of debt.
The ratio of debt-to-income for Australian households has increased by a factor of six since the 1990s.
Rather than having 98 cents for every dollar to spend on the regular necessities of life, you’ve now got about 85 cents and falling.
At some point you cross a line in which you are paying out more than your disposable income simply to cover your house repayments and bills. A lot of Australian people are now in that situation.
You say that, “the real debt story today lies with households who never had to work so long in the past to meet their interest commitments.” Are you saying that the debt crisis is now undermining living standards?
Oh yes, it certainly is. Recent research published by the Rudd government said that 1.1 million households are suffering severe mortgage and rental stress.
That gives you an idea of how widespread the problem is.
You argue that levels of household debt put us in “uncharted and dangerous waters”. Why?
One of the very many things wrong with the economics profession is that it completely ignores the role of credit and debt in the financial system.What’s happened has actually blind-sided much of the profession.
While we have supposedly had an inflation-dominated history since the mid-1960s, what’s actually been happening is a dramatic blow out in debt compared to incomes.
For example, in 1964 nominal GDP was $21 billion and the total debt of all households and businesses was $5 billion.
Inflation and real increases in output mean that total GDP is now one trillion dollars. But total debt is $1.7 trillion.Are you saying that this level of debt is a precursor to recession?
Yes. And not just any recession: it would be something much more severe than a straightforward recession because debt-to-income levels are literally twice what they were during the Great Depression.
The greatest previous debt-to-income ratio was back in the 1890s depression.
So each time we have debt anywhere near this proportion, once things turn around, we have moved from an apparently booming economy to a depressed one-and very rapidly too.
It’s a bit like the old Mark Twain saying, “History doesn’t repeat, but it sure does rhyme”.
You’ve also written that we are “to some extent quarantined from the US’s problems” with reference to China and the resources boom. But you don’t think this is enough to prevent an eventual downturn, do you?
No, that’s not enough. China is big-but it isn’t as big as America as a source of international demand.
A lot of the growth in China is endogenously generated. Its been suppressed for a long time and now it has its own internal boom. The same thing applied to Japan when it turned around after the World War II.
So there are some ways in which the growth will go on in China independent of what happens to its export markets.
But a large proportion of its growth is due to dramatic levels of investment, which are directed at both exports and local consumption. When it rebalances that investment demand could fall quite dramatically. So there’s no guarantee that that growth will continue indefinitely.
What has caused such excessive housing price inflation?It’s basically the myth that housing prices can continue rising faster than consumer prices forever. That has been going on for so long that it’s ingrained into the Australian psyche and, also, the psyche of the western world.
If we go back to the mid-1960s, debt levels were incredibly low-probably the lowest they have ever been. The baby boomers dived into the housing market, started borrowing, watching prices go up, and selling on to somebody else at a higher price who takes out more debt to buy it from them. We’re now reaching the stage where that’s been going on for 44 years.
But it seems that the most recent housing boom has been caused by policies such as negative gearing laws-which preference property investors-and the halving of capital gains tax.
If you take a look at the statistics, you can see that in 2004 the housing bubble stopped. Then it was re-started by the Liberals’ decision to double the first homebuyers grant and halve the rate of capital gain tax. It was successful for a short time, but only by maintaining an unsustainable trend for another three or four years.
You argue private debt levels are now so high that the Reserve Bank (RBA) has lost the ability to fine-tune the economy with interest rate changes.
I don’t think it ever had the ability to begin with. Controlling the rate of inflation with interest rates has turned out to be a myth. It’s a coincidence that inflation has been low while the RBA, and central banks in the rest of the world, have been varying interest rates.
The trouble is that because the central banks believe this myth, and because they are independent of government and can set their own policies, it puts the government in a bind in which they simply have to say that fighting inflation is the number one priority.Doesn’t this suggest that the neo-liberal ideology that underpins the RBA’s strategy is in trouble?
It is in serious trouble. It hasn’t actually bitten yet because we haven’t seen the inflation level rocket out of control-but this is feasible with both global warming and peak oil biting at the same time. Considering this has never happened before in human history, it’s a total wildcard.
At the other extreme, if we do have serious downturn, starting in the US and affecting the rest of the world, it could lead to a collapse in asset prices followed by a collapse in demand for commodities.
What are some practical steps that could be taken?
Abolishing negative gearing on existing properties [would help]. We could slowly wind it back so you don’t get negative gearing on future properties.
Secondly, we should return the level of capital gains tax back to the level of income tax so that we stop encouraging people to make money either by speculating or by re-disguising income as capital gains and reducing their tax bill.
Those things have to change. They are two of the worst, most damaging policies that the Howard government introduced.
Steve Keen is Associate Professor of Economics at the University of Western Sydney. He is the author of Debunking Economics and blogs at