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The Muddle of Macroeconomics

I never formally studied any economics at school or university, but in the years since I have become increasingly interested in the subject. I am sure that is evident from many of the posts here on the Stubborn Mule. What I did study was mathematics and, although there can be internal debates within the subject of mathematics, in the end it is usually clear what is right and what is wrong. No such luck in economics, particularly when economists attempt to understand the working of the world from the broadest perspective: macroeconomics. The level of controversy, debate and antagonism in the field of macroeconomics is quite extraordinary.

In July, The Economist’s cover story asked what was wrong with the field of economics. The leader was accompanied by an article entitled The other-worldly philosophers, which narrowed in on macroeconomics. It quotes Willem Buiter of the London School of Economics describing macroeconomics as a “costly waste of time”, while prominent economist Paul Krugman described most macroeconomics of the past 30 years as “spectacularly useless at best, and positively harmful at worst”. The article goes on to explore the tensions between free-market supporting “freshwater economists” and the more interventionist “saltwater economists”. Following a detente of sorts over recent years, the global financial and economic crisis has inflamed the antagonism once more.

In the May issue of The Monthly Magazine, former banker and author of “The Two Trillion Dollar Meltdown”, Charles R Morris wrote of macroeconomics:

macroeconomics is not a science. Its methods are gross and error-prone, and its models of economic reactions bear only a distant relationship to those in the real world. The theoretical apparatus of economics – its ‘laws’ – are mostly imaginative constructs that can rarely be confirmed with any precision, and stem more often from ideologies than from careful observation.

The issue of ideology is a crucial one. Any macroeconomic theory has implications for government policy, particularly monetary and fiscal policy. Further, almost all monetary and fiscal policy, even “doing nothing” has implications for wealth transfer from one segment of society to another. All things being equal, high interest rates are bad for borrowers and good for depositors. Inflation is good for borrowers and bad for lenders (update: this is really an over-simplification: see comments below). Some policies may benefit wage earners, but create costs for businesses, others may help importers but hinder exporters. With so much real money at stake, it is no wonder that ideological biases are so significant.

Once much of this debate would have been carried to the halls of academia, only reaching the rest of us in the form of those ideas which filtered through to influence the government of the day. These days it is all readily accessible online to anyone who is interested and many of the participants engage directly with the public on their blogs. I do not pretend to have all the answers (or even very many answers), so for now I will simply list just a few of the blogs and websites I have come across in my own quest to better understand this contentious field of study.

Billy Blog

Bill Mitchell is a professor in economics at the University of Newcastle (Australia). He describes himself as a “modern monetary theorist” and focuses on the mechanics of money. On his blog, he argues forcefully that much of the thinking of mainstream macroeconomics, particular that of a neo-classical bent, has not come to terms with the implications of “fiat money” and are steeped in gold standard thinking. This position leads him to advocate strongly for the importance of government spending, particularly to support full employment, and dismiss concerns about budget deficits threatening government solvency. While this may sound Keynesian, Mitchell dislikes the The General Theory of Employment, Interest, and Money and distances himself from aspects of Keynesian thinking which can itself be caught up in misunderstandings of the mechanics of money. While Mitchell does not shy away from expressing his ideological views, he would also argue that his thinking does indeed begin with careful observation.

The Conscience of a Liberal

With the Nobel Prize for Economics in 2008 and a number of popular books under his belt, Paul Krugman is the best known of the economists in this list. Krugman’s approach to macroeconomics is more firmly in the Keynesian tradition than Mitchell’s and he has been a passionate advocate online and on television for extensive economic stimulus packages, as well as an ardent critic of much of the way that bailout of US banks was handled. Like Mitchell, Krugman dismisses concerns about escalating government debt.

Maverecon

Having been a member of theBank of England’s Monetary Policy Committee, Willem Buiter has direct experience of the real world operation of monetary policy. In his blog he criticises the whole enterprise of macroeconomics, attacking both the neo-classical and the neo-Keynsian schools of thought. Buiter has more time for “heterdox” economic thought that attempts to deal with the messier realities of the economy, such as inefficient markets, illiquidity and irrational behaviour.

Von Mises Institute

Many economists, Krugman included, dismiss the Austrian school of economics as an oddball fringe distraction from the real business of economics. However, the Austrian way of thinking has a surprisingly strong hold on the thinking of a number of people outside the economics profession. I suspect that this is due, in part, to the fact that a number of the school’s classic books such as Hazlitt’s “Economics in One Lesson”, are easily accessible to non-economists. Among the recurring themes of the Austrian school are the evils of fiat money, fractional reserve banking and the intervention of central banks in free markets. While many of their arguments that get them to these stark conclusions initially have superficial appeal, I have not found that they stand up to closer scrutiny. Presumably this is why they are not taken very seriously by most professional economists. Either that or all professional economists are either deluded fools, or swayed by vested interested or both, which I am sure would be the Austrian’s counter-argument. Indeed, another thread running through the Von Mises Institute blog and other Austrian school writings is an acrimonious tendency to ad hominem attacks on their opponents, particularly Krugman.

Econbrowser

Written by James D. Hamilton, Professor of Economics at the University of California, San Diego and Menzie Chinn, Professor of Public Affairs and Economics at the University of Wisonsin, this blog has a strong focus on data analysis, which clearly appeals to me. Nevertheless, their attitude towards government debt does show signs of the sort of gold standard thinking that Bill Mitchell criticises.

The Daily Reckoning and Money Morning

I have grouped these two blogs together as they seem to share a number of contributors and have a similar style and outlook. Many of the writers are Austrian school fellow travellers and like nothing more than a rant about the evils of fiat money, except perhaps a rant on why the banking system is a giant Ponzi scheme. I primarily visit these sites if I am looking for a bit of an adrenaline boost or an argument.

Steve Keen’s Debtwatch

Steve Keen is another iconoclastic opponent of neo-classical economics. His book Debunking Economics was an attack on the traditional underpinnings of neo-classical macroeconomics. Most of the writings on the blog focus more on his concerns about the growth in private sector debt in Australia and the US. The concerns lead him to his pessimistic view of the prospects for the Australian housing market, a view he is best known for in the mainstream press and one I have discussed elsewhere.

Photo credit: p22earl on flickr (cc licence).

How Important Is China?

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Today I attended a presentation by TD Securities global strategist Stephen Koukoulas. While exploring the “green shoots” of recovery, Koukoulas made an interesting observation about China. Many observers of the Australian economy, Reserve Bank governor Glenn Stevens included, place great weight on the importance of China for Australia’s economy. But Koukoulas pointed out that, while exports to the US make up over 20% of Canada’s GDP, Australia’s exports to China only contribute 3% of GDP. In fact, the Australian Capital Territory (ACT) contributes more to GDP than China does.

As soon as I got back to my desk, I went straight to the Australian Bureau of Statistics to confirm these figures. Sure enough, merchandise exports to China for the 12 months to March 2009 were 3.1% of seasonally adjusted GDP, while the contribution of the ACT to GDP was 3.2%. So far, so good, but a historical perspective is revealing.

Australian Annual Exports to China

While the contribution of Chinese exports is still relatively small, it has been accelerating over the last few years. Over the 12 months to March 2009, Chinese exports grew by 0.8%, so they were a significant contributor to economic growth, despite the low base. Not surprisingly, China has been taking a growing share of total Australian exports over this period.

China’s Share of Total Australian Exports

As for the nation’s capital (and surrounds), on current trends, it will not exceed China for very much longer.

ACT versus Exports to China

Of course, these figures do not disentangle volume and price effects and whether or not China’s own growth will remain strong enough to keep pushing our exports up is an interesting question. But, based on these charts, I can understand why Glenn Stevens considers China so important for an economic recovery.

Note: the code used to produce these charts is available on github.

Taking It Too Far: Verb and Adjective Clouds

Malcolm Turnbull’s Word Cloud

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My last post looked at the favourite words of Australia’s prime minister, Kevin Rudd. In the interests of balance, I will now turn the word cloud lens onto the opposition leader, Malcolm Turnbull. Turnbull’s speeches are conveniently assembled online and the graphic below illustrates the frequency of his words from speeches made in 2009. Unlike the analysis of Rudd’s speeches, this analysis does include some speeches given in parliament.

Just like Rudd, Turnbull’s favourite word is “Government”, and “Australia” is not far behind. But from there, differences appear. The word “billion” is far more prominent, reflecting the opposition leader’s obsession with growing public debt. The appearance of “Rudd”, “Labor” and “Coalition” clearly reflect the realities of life in opposition where so much time is taken attacking the other side.

Interestingly, the word “emissions” is clearly visible in the cloud, whereas nothing relating to climate change was visible in Rudd’s cloud.

“Now” is as prominent as Rudd’s “also”. Does this reflect a constant sense of urgency from a man of little patience?

Where Have the Fish Come From?

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After reading my posts on the international arms trade, a friend thought I might be interested in some data on the international trade in fish. While I know almost as little about fish as about arms, I always welcome good data. The data in question is published by the Food and Agriculture Organization (FAO) of the United Nations. The FAO also hosts FAOStat, which looks like an interesting data repository. If I can get myself a subscription to this service, it may provide the subject matter for future posts on the Mule.

But back to the fish. The first point my correspondent made was that many fish exporters are also importers. Among the top 50 importers of fish, all but 16 countries also appear in the list of the top 50 exporters. The chart below* gives an indication of the relative scale of fish imports and exports in 2006 of the top 10 importing countries. Of these big importers, only China and Denmark export even more fish than they import.

Fish Trade by the Top 10 Importers (2006)

But the real mystery my fishy correspondent alerted me to is the difference between total worldwide imports and exports of fish. According to the figures, total worldwide imports of fish amounted to US $89.6 billion while exports only amounted to US $85.9 billion. That would appear to mean that US $3.7 billion worth of fish was imported in 2006 from nowhere! While I am sure that statistics of this kind may not be too accurate, the report does report each country’s trade figures to the nearest US $1000, so it seems to be a big difference. I speculated that some countries were not admitting to exporting whale meat to Japan, but my correspondent pointed out that whales are not fish. While the US Supreme court has ruled that tomatoes are vegetables, I do not know their view on whales, and this is probably not the answer anyway. Any theories out there, readers?

At the suggestion of singingfish, I will be making available the code used to produce charts here on the Stubborn Mule. Most of the charts are produced using the R statistical package, which is free and open-source. R can be downloaded here. The data and code for the chart above is here. I will gradually add the code for charts from older posts as well.

UPDATE: I forgot to mention that my correspondent also suggested fish rain as an explanation. I, however, am not convinced. Regardless of the original source, I am sure most countries would treat fish rain as a natural bounty rather than an import.

* Tip for reading the chart: there is no label on the right hand side for the USA and no label on the left for Denmark, but following the lines should make it obvious where they would be if there was room.

The Big Arms Traders

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My last post looked at the international arms trade. Taking data from SIPRI, I produced maps showing arms exports for a number of countries, including Australia and the USA. While these maps gave an indication of the spread of arms trading, it did not show which are the biggest overall importers and exporters of arms.

To remedy this, I have created two “word clouds”. The first shows arms importers. The size of the text varies with the total value of arms imported over the period 1980 to 2008 (figures are adjusted for inflation and are expressed in 1990 US dollars). The three biggest arms importers over this period were India ($58 billion), Japan ($37 billion) and Saudi Arabia ($35 billion). Australia’s imports over this period totaled $15 billion.

Arms Importers (1980-2008)

The word cloud for exporters is far more concentrated. Between them the USA and Russia* accounted for almost 65% of total arms exports, with exports of $60 billion and $48 billion respectively. France then comes in at a distant third with exports totaling just under $12 billion.

Arms Exporters (1980-2008)

If you like the look of these word clouds, you can easily create your own. With Wordle you can create word clouds which are based on word frequency. This example is based on words used here on the Stubborn Mule (notice the prominent appearance of the word “debt”). For a bit more flexibility, IBM have a freely available Word-Cloud Generator, which can either work on word frequencies or take columns of words and numbers. It is written in java and is very easy to configure and run. I used it to produce the images in this post.

* As in the previous post, figures for the USSR and Russia have been aggregated.

The Arms Trade

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Yesterday iconoclastic commentator on technology, politics and culture, Stilgherrian, shared an interesting discovery on twitter. He had come across the website of the Stockholm International Peace Research Institute (SIPRI) and their Arms Transfer Database. SIPRI has been monitoring international arms trades since 1968 and in the process have assembled an extraordinary database with details of all international transfers of major conventional weapons since 1950. Since March 2007 this database has been available online.

The business of international arms trading is certainly not within my area of expertise, but a rich data-set like this presents a perfect opportunity for a type of data visualization that has not yet appear on the blog: maps. The SIPRI database provides “Trend Indicator Value (TIV)” tables which aggregate trade values between countries. Values are inflation-adjusted, expressed in 1990 US dollars.

Starting with Australia, the data shows that the total value of arms imported by Australia from 1980 onwards exceed exports by a factor of almost 30 times. Imports are largely sourced from North America and Europe, while exports are spread more broadly and include a range of Asian and Pacific countries. Click on the charts to see larger images.

Arms transfers from Australia (1980-2008)

Arms transfers to Australia (1980-2008)

Needless to say, the distribution of arms transfers in and out of the USA looks very different. Over the last 30 years, the USA has exported arms to well over 100 countries across every continent other than Antarctica.

Arms transfers from the USA (1980-2008)

Arms transfers to the USA (1980-2008)

Another big exporter of arms to a wide range of countries is the United Kingdom.

Arms transfers from the UK (1980-2008)

Arms transfers to the UK (1980-2008)

Russia offers a rather different distribution of arms transfers. Russia has exported arms to almost 100 counties, most notably China, but since 1980 has only imported from Germany, Poland and the Ukraine.

Arms transfers from Russia (1980-2008)

Arms transfers to Russia (1980-2008)

I will not offer any further comment on this data, but will leave the maps to speak for themselves. If you would like to see a map for any other countries, feel free to contact me on twitter, @seancarmody. I will add them to this flickr image set.

UPDATE: As Mark Lauer correctly pointed out, these maps were originally inaccurate when it came to countries which were formerly part of the Soviet Union. This has now been corrected in the maps above.

Deleveraging and Australian Property Prices

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car-small A few weeks ago, I had a preliminary look at Australian property prices. That post focused on rental yields and argued that the fact that property prices have consisently outpaced inflation over the last 10-15 years can be associated with a steady decline in rental yields which has been matched by a decline in real yields in other asset classes. What I did not address was the argument that debt deleveraging will lead to a collapse in property prices just as it has done in the US. That is the subject of today’s post.

The Bubble

The bubble argument is a compelling one. The chart below shows the growth in Sydney property prices over the last 24 years. Prices rose fairly consistently over this period at an annualised rate of almost 7%. Over this period, inflation averaged around 3% per annum, so property prices grew at a rate of approximately 4%. This means since 1985, the cost of a typical house has risen by a disconcerting 123% over and above inflation. Little wonder that many people see the property market as a bubble waiting to burst.

Sydney Property Prices (1985-2009)*

The fuel driving the property market has been the rapid growth in household debt, most of which has been in the form of mortgage debt. The next chart is taken from Park the Debt Truck!, a post which looks at trends in Government and household debt in Australia. The highlighted regions show the periods of Labor federal governments. Household debt began its upward trajectory during the Hawke and Keating years, but really gathered pace during the Howard years. With the help of continually extended first-time home-buyer grants, growth is yet to slow now that Rudd has come to power.

Govt and Household Debt

Government and Household Debt in Australia

This expansion of debt has been a key factor driving up property prices. Without the easy access to money, the pool of potential home-buyers would be far smaller and with less demand pressure, prices would not have risen so fast. A very similar pattern was evident in the US, but in late 2006 the process began to lose steam. Property prices faltered, debt became harder to obtain, borrowers began to default on their loans leading to foreclosure sales which put further downward pressure on prices. The bubble was bursting.

So far I am in agreement with the property bubble school of thought. Where I part ways is concluding that Australia will inevitably experience the same fate, resuting in a collapse in property prices, possibly in the range of 30 to 40%.

Deleveraging

Words can be powerful. Once you use the word “bubble” to describe price rises, it seems almost inevitable that the bubble must burst. Similarly, “reducing debt” sounds like a good thing, while “deleveraging” sounds like a far more ominous destructive process. But all deleveraging really means is debt reduction and it can happen in a number of ways:

borrowers use savings to gradually pay down debt
borrowers sell assets to pay down debt
borrowers default on their loan

When it comes to borrowers selling assets, in some cases this may be voluntary. But it may be that they are forced to sell. A good example is in the case of margin loans to purchase shares. If the share price falls, the lender will make “margin call”, requiring the borrower to repay some of the loan. Selling some or all of the shares may be the only way to raise the money required. When borrowers default on a secured loan (such as a mortgage), the lender will usually sell the asset securing the loan in an attempt to recover some of the money lent. In this situation the emphasis is usually on ensuring a speedy sale rather than maximising the sale price.

Forced sales are the ideal conditions for a price collapse, particularly if lenders have become reluctant to finance new borrowers. If debt reduction takes the form of gradual repayment, the pressure on prices is far less. There will certainly be less demand for assets than during a period of rapid debt increase, but this can simply result in neglible growth in asset prices for an extended period of time rather than a price collapse.

To understand what form debt reduction will take, it is not enough to consider the amount of debt. The form of the debt is very important. Some of the key characteristics that will influence the outcome include:

the term of the loan (the length of time before it must be repaid)
repayment triggers (such as margin calls)
interest rates

Short-term loans can be very dangerous. In 2007, the non-bank lender RAMS learned this the hard way. It had relied heavily on very short-term funding (known as “extendible asset-backed commercial”) and back when the global financial crisis was simply known as a liquidity crisis, RAMS found itself unable to refinance this debt. It’s business collapsed and it was purchased by Westpac for a fraction of the price at which the company had been listed only months before.

The most common type of loan with repayment trigger is a margin loan. There is no doubt that a significant factor in the dramatic falls in the Australian sharemarket over 2008 was forced selling by investors who had used margin loans to purchase their shares. There are also other sorts of loan features than can be problematic for borrowers. Another one of the corporate victims of the financial crisis was Allco Finance. It turned out that they had a “market capitalisation clause” attached to their bank debt. This was like a margin call on the value of their own company and was an important factor in the collapse of the company.

Even if borrowers have long-term loans and are not forced to repay early, if they are unable to meet interest payments, they will be in trouble. A common feature of the US “sub-prime” mortgages at the root of the financial crisis was that interest rates were initially low but then “stepped up” a couple of years after the mortgage was originated. While the market was strong, this was not a problem due to the popular practice of “flipping” the property: selling it for a higher price before the interest rate increased. Once prices began to fall, the step-ups became a problem and mortgage delinquencies (falling behind in payments) and defaults began to rise. In some states, the phenomenon was exacerbated by laws that allowed borrowers to simply walk away from their property, leaving it to the lender, who had no further recourse to pursue the borrower for losses. On top of all this, rapidly rising unemployment put further stress on borrowers’ ability to service their mortgages.

So, how do Australian mortgages look on these criteria? The standard Australian mortgage is a 25-30 year mortgage with no repayment triggers. Most mortgages are variable rate and, despite the banks not passing through all the central bank rate cuts, mortgage rates are at historically low levels. In part due to the regulatory framework of the Uniform Consumer Credit Code (UCCC), lending standards in Australia have been fairly conservative compared to the US and elsewhere. The Australian equivalent of the sub-prime mortgages, so-called “low doc” or “non-conforming” mortgages, represent a much smaller proportion of the market. Many lenders cap loan-to-value ratios (LVR) at 95% and require the borrower to pay mortgage insurance for LVRs over 80%, which encourages many borrowers to keep their loans below 80% of the value of the property. Interest step-ups are rare. Mortgages are all full recourse.

The result is that while US mortgage foreclosure and delinquency rates have accelerated rapidly, they have only drifted up slightly in Australia. It is not easy to obtain consistent, comparable statistics. For example, deliquency data may be reported in terms of payments that are 30 days or more past due, 60 days or more or 90 days or more. Of course, figures for 30 days or more will always be higher than 90 days or more. Nevertheless, the difference in trends is clear in the chart below which shows recent delinquency rates for a variety of Australian and US mortgages both prime and otherwise. The highest delinquency rates for Australia are for the CBA 30 days+ low doc mortgages. Even so, delinquencies are lower even than for US prime agency mortgages 60 days+ past due.

Delinquency Rates (III) Delinquency Rates in Australia and the US**

All of this means that the foreclosure rate remains far lower in Australia than in the US. Combined with the fact that mortgage finance is still increasing, due largely to the ongoing first-time home-buyers grant, there has still been little pressure on Australian property prices. In fact, reports from RP Data-Rismark suggest prices are on the rise once more (although I will give more credence to the data from the Australian Bureau of Statistics which is to be released in August).

Once the support of the first-time home-buyers grant is removed, I do expect the property market to weaken. Prices are even likely to fall once more with the resulting reduction in demand. However, without a sustained rise in mortgage default rates, I expect deleveraging to take the form of an extended lacklustre period for the property market. Turnover is likely to be low as home-owners are reluctant to crystallise losses, in many cases convincing themselves that their house is “really” worth more. Even investors may content themselves reducing the size of their debt, continuing to earn rent and claim tax deductions on their interest payments.

The biggest risk that I see to the Australian property market is a sharp increase in unemployment which could trigger an increase in mortgage defaults. To date, forecasters have continued to be confounded by the slow increases in unemployment and now the Reserve Bank is even showing signs of optimism for the Australian economy.

Australian property prices have certainly grown rapidly over recent years. Driven by rapid debt expansion, prices have probably risen too far too fast. But, calling it a bubble does not mean it will burst, nor does using the term “deleveraging” mean that prices will inevitably follow the same pattern as the US. In the early 1990s, Australia fell into recession and the commercial property market almost brought down one of our major banks. Meanwhile, house prices in the United Kingdom collapsed. Despite all of this, in Australia, residential prices simply slowed their growth for a number of years. I strongly suspect we will see the same thing happen over the next few years.

* Source: Stapledon

** Source: Westpac, CBA, Fannie Mae, Bloomberg.

By the way, notice anything unusual in the picture at the top?

UPDATE: Thanks to Damien and mobastik for drawing my attention to this paper by Glenn Stevens of the Reserve Bank of Australia. It includes a chart comparing delinquency data for the US, UK, Canada and Australia. The data is attributed to APRA, the Canadian Bankers’ Association, Council of Mortgage Lenders (UK) and the FDIC. Since these bodies do not appear to make the data readily available, I have pinched the data from the chart and uploaded it to Swivel. It paints a very similar picture to the chart above.

Delinquency: US, UK, Canada and Australia Mortgage Delinquency Rates

Park the Debt Truck!

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About two months ago, I tried to bring some perspective to concerns about growing government debt in Australia. Last week the opposition has rolled out the “debt truck” to add to the hysteria about growing government debt, so I feel compelled to return to the subject for another attempt.

Last time I looked at net debt data going back to 1970. The data came from a chart in the Treasury paper “A history of public debt in Australia”. The paper also shows a history of gross debt and although I prefer to use net debt, the gross debt data goes back further, all the way to 1911 and so gives a longer historical perspective. As usual, I have posted the data on Swivel.

The alarmists like to trade in dollar figures, pointing to forecasts that gross government debt will peak in 2014 at $315 billion, which will be an all-time record. Of course, that ignores the effects of inflation, so it makes far more sense to look at the debt as a percentage of gross domestic product (GDP). Expressed this way, the 2014 forecast amounts to an expected 21% of GDP (while net debt will be 14%). As is evident in the charts below, this is about the same as in the years following the recession of the early 1990s and it is nowhere near levels in the more distant past. Immediately after World War II, gross debt reached an enormous 125% of GDP.

History of Government Debt

Figure 1 – Australian Government Debt (1911-2008)

If you are wondering about the shaded bands in these charts, they indicate periods of Labor Governments. The opposition is fond of saying that debt falls under Coalition governments and rises under Labor governments. Looking at the data, it is certainly true that government debt fell through both the Menzies and the Howard years (a pairing that would, I am sure, warm the cockles of our previous prime minister’s heart). Beyond that, the link is not so clear cut. What seems more apparent is that government debt fell during good economic times and rose during bad economic times and, moreover, the Coalition have not had a monopoly on good economic times nor Labor on bad. This pattern should not be the least bit surprising. When the economy booms, tax receipts rise and unemployment falls, reducing the cost of welfare payments and when it falters, the opposite occurs. As a result, the government tends to run fiscal surpluses in the good times, paying down their debt, and deficits in the bad times, increasing debt once more.

Recent History of Government Debt Figure 2 – Australian Government Debt (1960-2008)

What the debt demonisers fail to realise is that this counter-cyclical pattern of government spending is a good thing. The increase in welfare spending in troubled economic times helps boost economic activity, softening the impact of a slowdown, which is why welfare spending is often referred to as an “automatic stabiliser”. In more extreme downturns, such as the one we currently face, the government can supplement the automatic stabilisers with additional stimulus spending.

More importantly, government debt is very different from personal or business debt and is not something to be afraid of. In Australia, we have a currency that is not tied to other currencies, nor to gold or any other commodities. It is “fiat money”, effectively under the control of the government. Furthermore, all of the government’s debt is denominated in Australian dollars. This means that the government can, in fact, never run out of money, unlike individuals or businesses. So, any comparison between government debt and household debt is meaningless. Of course, in practice, governments should control their spending. If they kept increasing spending when the economy was strengthening, there would come a point where this spending would become inflationary. But this is a very different kind of constraint than I face on my spending! To dig deeper into the implications of fiat currency, monetary theory Bill Mitchell has a lot of material on the subject on his blog. A good place to start is his post on gold standard myths.

So, there is no substance to the fear that the opposition is trying to excite with their debt truck. Government debt is not what we should be worrying about. What is more concerning is private debt. Since individuals cannot issue new currency to repay their loans, excessive household debt can be a real concern. And, the chart below shows that there is something to be worried about. While the Coalition may be very proud of the record of government debt reduction during the Howard years, they should not be so happy about what happened to household debt under their watch (and you thought I was being easy on Howard before!). Instead of focusing on the possibility that government debt may reach 14% of GDP by 2014, perhaps the opposition’s debt truck should drive around the country alerting everyone to the fact that household debt is already over 100% of GDP.

Govt and Household Debt

Figure 3 – Household and Government Debt (1976-2008)

Of course, there are some commentators, such as Steve Keen, who are rightly concerned about the excessive levels of household debt. It is very likely that Australia and many other developed countries around the world will experience an extended period of private sector “deleveraging” (debt reduction). As long as consumers are saving rather than spending, this will translate to far lower economic growth than we have been used to in recent years.

To this point, I agree with Keen. Where I disagree is the extent to which this deleveraging will result in massive declines in Australian property prices. But that is a topic for another post, the long awaited sequel to my recent post on property prices.

UPDATE: for a Nobel Prize-winning perspective, here is Paul Krugman arguing that government deficits saved the world.

No Alternative View of Dubai

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Back in April, I announced that the Mule was to be graced with a guest post providing an alternative, more positive picture of Dubai than the one painted by The Independent. Sad to say, although written, the piece is not going to see the light of day. My guest poster’s employer has ruled out any scope for publishing the piece, even if it is done anonymously.This experience suggests to me that on the score of openness at least, Dubai does not do well!

I was excited at the prospect of the occasional different voice here on the Mule, so if anyone has something they are itching to share with the world, let me know. There could be a guest spot for someone here yet!