Therapy for grieving Australian progressives


Progressive voters in Australia expected that last weekend's election there would bring to an end six years of rule by the Liberal Party (which, despite its name, is the country's conservative party). Every poll for three years had predicted their demise: it was done and dusted. Progressives held election parties across the country, ready to celebrate Labor's victory.

Then Labor lost. Those parties turned from celebration to grief. Glen Le Lievre's cartoon below sums up how many of those progressive voters are feeling about Australia right now.

Figure 1: Glen Le Lievre's brilliant post-election cartoon. Please join me in supporting Glen on Patreon!

I was more sanguine. I had argued in a blog post one month ago that this would be a very bad election to win (Why I'm voting Liberal, and why other progressives should too). Australia's housing bubble had ended, and I expected the house-price-crash-led economic downturn that the USA had experienced in 2008 to be replayed in Australia in the next 3 years. Whatever party was in power would be blamed for the crisis, when in fact it was just unlucky: the process that set up the economic crisis Australia will experience in this electoral term had started many decades earlier.

If Labor had won the election, it would have walked into an economic crisis for which it was not only not responsible, but also not prepared. Its core economic policy, of returning the government's budget to surplus—a policy it shares with the Liberal Party—would actually make things worse. Circumstances would force it to run deficits instead—big ones—which the Murdoch Press would have pilloried it for, and the deficits would have described as the cause of the crisis.

The "lesson" the Australian electorate would have learnt from that experience is the same one it learnt under the Whitlam Labor Government of 1972-75, the final years of the Hawke-Keating government of 1983-1996, and the Rudd-Gillard-Rudd Government of 2007-2013: that you can't trust Labor with the economy.

The public, having experienced years of declining unemployment under the preceding Liberals, and then economic chaos under Shorten, would be waiting for Labor with a baseball bat at the next election. This year's narrow victory would be followed by a crushing defeat in 2022, under a far more conservative Liberal Party than the one it had beaten in 2019.

This has happened before, when then Liberal Party leader John Hewson lost "the unlosable election" to Paul Keating in 1993. What did that Labor success give us? Not much during Keating's final term, and then three years later, it gave us John Howard, the Tampa Affair, Children Overboard, "we will decide who comes to this country and the circumstances in which they come", and all the other many travesties that have made socially progressive people to be ashamed to call themselves Australians, when once they were proud.

Having met John Hewson on several occasions, as well as having followed him in the media over the years, I am 100% confident that none of that would have happened had he won the 1993 election. He is simply far too decent a human being. While Paul Keating's win then was great for Labor at the time, it was lousy for Labor and the country at the subsequent election and the following decade. I wish Keating had lost.

What if Shorten had won the 2019 election? My expectation was that he would have walked into a bigger, uglier and more intractable crisis this time than at any other time a Labor Government had taken over from an incumbent Liberal one. And the symptoms of that crisis, the things the government has no choice but to do—increase welfare spending, take in less tax revenue, and therefore run a large deficit—would have been blamed for the crisis itself, as happened to Rudd, and Whitlam before him (and Keating too, though Keating's case is a special one). The mantra would once again be that Labor is irresponsible, that only the Liberals can be trusted to run the country well by seriously aiming for a government surplus, and that you can't trust Labor with the economy.

"Scomo" is no John Hewson—far from it. But what if Shorten had beaten him, and then the Liberals had turned to Peter Dutton as leader? You might think that improbable, but Howard once described himself as "Lazarus with a triple by-pass" to characterise how often his political career had come back from the dead.

Given those prospects, and what I expected to occur in the Australian economy over the next three years, I preferred to let this Hospital Pass of an election go to the Liberals.

There's also a learning issue here. If you're hurting over the election results, you're also questioning the capacity of the majority of your fellow Australian voters to understand the issues confronting society today. Progressive Americans felt the same way about their country when it elected Trump. But look at the level of the US debate today over economic policy (and to some extent, climate policy, with the Green New Deal): the issue of whether a government should aim for surpluses (conventional economic theory) or deficits ("Modern Monetary Theory") is now being debated everywhere from the New York Times ("Modern Monetary Theory Finds an Embrace in an Unexpected Place: Wall Street") to Congress ("Debate rages over practicality of modern monetary theory").

We can't even get to first base on those debates in Australia right now. One reason that the USA is streets ahead on both—even if they did elect Donald Trump—is that they experienced the Global Financial Crisis, whereas Australia side-stepped it. All the old certainties disappeared after that for Americans. In contrast, the dominant attitude to Australia's economy, especially amongst its economic advisors, can be summed up in one word: smug.

If Australia was ever going to learn the right lessons—that credit bubbles have caused Australia's past booms, that credit busts caused the downturns, and that the banking sector has to be seriously reformed to avoid future crises—I felt that it was more likely to do so if a Liberal Government was in charge of the economy when this next crisis happened. So, though I would have had to hold my nose and cover my eyes as I did it—because I loathe the "Liberals" for their non-economic policies: their climate change denialism, their assaults on the ABC, their punishment of the unemployed, and many others—I decided that I'd vote Liberal this time around, and I recommended the same policy to other progressives.

Figure 2: My April 15 post recommending a "hospital pass" vote for the Liberals

As it happens, I couldn't vote anyway: I've lived overseas for too long. So I sat back to watch the process, knowing that progressives would be joyous at Shorten's victory. I'd be glad too to see the Liberals booted out, and pleased to see decent policies enacted on social security, some climate change abatement (though far too little and too late), reviving the ABC, and so on. But I had also resigned myself to watching the same old story play out over the next three years, that a credit crunch would bring the economy undone, Labor would get the blame, and a resurgent Liberal Party would triumph in 2022.

But it didn't happen. Australia did vote the Liberals in—not for the far-sighted reasons that I recommended they get given the political football of course, but because their "Fistful of Dollars" electoral campaign worked, while Labor's failed (particularly, but not exclusively, in Queensland).

So now, my hypothetical has become real. The Liberals have won the Hospital Pass election, and now will have to cope with what is coming.

My expectation is that Australia is about experience something very similar to what happened to the USA in 2008. That crisis, like every other financial crisis in the last 150 years, was the result of a collapse in credit-based demand from a position of too much private debt. The next few charts juxtapose the debt-dynamics that brought the US economy undone in 2008 with the same factors in Australia. I use the same scale on relevant graphs so that you can see how much further Australia has gone up the bubble track than the USA.

Firstly, house prices and household debt. The USA maxed out at house prices being 2.6 times 1971 levels at the peak of the bubble in early 2006, while household debt peaked at just under 100% of GDP in 2008. The gap between peak house prices and the GFC was just under two years.

Figure 3: USA House Prices and Household Debt

What wimps! Australian household debt hit 122% of GDP in early 2017, 25% above the US peak. House prices peaked at 3.6 times 1971 levels before the downturn began in mid-2017—about two years ago. So Australian real estate is more leveraged and more inflated than even Subprime USA.

Figure 4:Australian House Prices and Household Debt

The driving force behind house prices is household credit: houses are overwhelmingly purchased with mortgage debt rather than saved money, so the monetary demand for houses is fundamentally new mortgages. Divide new mortgages by the price level, and you have the physical demand for houses per year. The rate of change of new mortgages—which is pretty close to the rate of change of household credit—is therefore what determines the rate of change of prices. The correlation between change in household credit and change in real house prices in the USA over the last 47 years is 0.65.

Figure 5: Relationship between change in household credit and change in house prices, USA

I keep being told that Australia is different: I call it the Marsupial theory of house prices. And it's true: the correlation here is only (in case Australians have lost their sense of humour, that is sarcasm) 0.55.

Figure 6: Relationship between change in household credit and change in house prices, USA

Australia has kept its housing bubble going by a set of policies that have only worked because they've encouraged Australian households to take on ever increasing levels of debt. This is what enabled the Australian economy to avoid a recession for 28 years: by keeping the growth in household credit positive, it has kept house prices rising, and by keeping total credit itself positive, it has avoided a recession. Since 1992, the increase in household credit has averaged half a percent of GDP per year (0.54%), while the aggregate level of credit—the sum of change in household and corporate debt—has averaged 11% of GDP per year.

This has obviously worked to avoid a recession, but the downside is that it has driven Australia's household debt level from one of the lowest on the planet to the second highest. As Figure 7 shows, Australian household debt in 1992 was well below the international norm. It has since risen to be the second highest after Switzerland today, and the third highest ever recorded (behind Denmark).

This trend of rising household debt compared to GDP ended in 2016, as Figure 7 also shows. The change in household credit since then has averaged minus 0.3% of GDP per year, and it is currently minus 2% per year (see the blue plot in Figure 6). I expected this trend to continue and finally cause Australia to experience negative credit and therefore a recession in the next 1-2 years—before the election of a Prime Minister who used to work for the Property Council of Australia.

Figure 7: Household debt levels around the world

So could ScoMo revive the housing bubble, and thereby avoid a recession in his first term? There's no doubt he'll try—the scheme to give 10,000 first home buyers (about 10% of the total annual market) a government guarantee of 15% of the purchase price was an obvious opening salvo. The RBA will help too, by cutting interest rates, while APRA has already done its bit by loosening credit standards after the ink on the Banking Royal Commission has barely dried. But to succeed, he'll have to encourage Australian households in the aggregate to take on even more debt.

The odds of that succeeding appear slim, once you look at Australia's private debt levels in both comparative and historical context. As well as having the second highest household debt to GDP ratio in the world, Australia has the highest household debt service ratio in the world (see Figure 8).

Figure 8: Debt service ratios, including interest and principal payments

Historically, this is the highest level of private debt that Australia has ever carried. It dwarfs not just the Great Depression, but even the Depression of the 1890s, which, though it's largely forgotten these days, was a far more severe crisis for Australia than the Great Depression.

Figure 9: Australia's long-term private debt and credit data

There truly would be something magical about Australia if it can return to rising private debt levels again, from this exalted level. Even the USA couldn't manage that feat. That's why the GFC was such an acute crisis for the USA: it fell severely into negative credit.

Figure 10: USA's long-term private debt and credit data

To avoid negative credit, Australia will need to get back onto its post-WWII trend of an exponential rise in the ratio of private debt to GDP (see Figure 11).

Figure 11: Maintaining positive credit by an ever-rising private debt ratio

This is possible, but highly unlikely. For starters, there are under a dozen countries that have higher private debt levels now than they did at the GFC: Australia, Belgium, Canada, China, Finland, France, Hong Kong, South Korea, Sweden, Switzerland and Turkey. Australia has the highest household debt service ratio of them all already (see Table 1). If the RBA cuts its rate to zero, and if all of this cut is passed on to mortgagees, then the debt service ratio will fall. But if credit is to remain positive, household debt levels will have to rise—offsetting the fall in interest rates.

Table 1: Debt, credit and debt service ratios for countries with higher debt now than at the GFC

My expectation before the election was that this trend of falling household credit would continue, leading to both household and corporate credit turning negative, as they did in America during the GFC. The change in total credit from plus 15% of GDP before the GFC to minus 5% during it is what caused the GFC.

Figure 12: Private actual and post-WWII till GFC trend debt and credit, USA

Table 2: Debt, credit and debt service ratios for countries with lower debt now than at or shortly after the GFC

Some of Labor's policies would have accentuated the trend of falling house prices: the restriction of negative gearing to new properties only being one example. This is not criticising that policy, which I was heartily in favour of: I'm just pointing out an unintended side-effect which would have added to the reputation Labor has copped for being poor economic managers.

Then Australia elected an ex-property spruiker as PM. Restricting negative gearing is off the menu, and a swathe of policies aimed at reflating the housing market are coming our way.

At the moment, the trend is for household debt to fall, rather than rise (see Figure 7). Interest rate cuts by the RBA, APRA's loosening of credit standards less than a year after the Banking Royal Commission's damning findings of bank fraud, and the already-announced reincarnation of the First Home Vendors Scheme will push against this (and no doubt the scheme will be extended beyond its current token level of just 10,000 recipients out of about the roughly 100,000 first home buyers each year, if the current fall in house prices continue). But with Australia already at world-record levels of household debt and household debt service, these policies are likely to be far less effective than they were in the past for Keating, Howard, and Rudd.

Other headwinds to rising household debt exist that Keating, Howard and Rudd didn't have to contend with.

The most significant here is the huge number of "interest only" housing loans—650,000 loans worth $230 billion, according to Morgan Stanley—that are going to reset in the next few years to interest plus principal, resulting in about a 40% increase in debt servicing costs.

Figure 13: Morgan Stanley's estimate of the fraction of interest only mortgages plus reset dates

With house prices in Sydney and Melbourne already down by 10% or more from the mid-2017 peak, many of these will be forced to sell when the reset occurs. A substantial fraction of mortgagees are already in negative equity—about 3% of all mortgagees, according to Martin North.

Figure 14: Martin North's negative equity data

APRA has cut its lending assessment standards, and is encouraging banks to get back into the irresponsible lending business. However, banks themselves are so scarred by the Royal Commission experience that they are enforcing higher lending standards internally, and they are unlikely to respond to APRA's siren call lest their new chairmen and CEOs experience the ignominy endured by Ken Henry and many others.

Figure 15: Ken Henry announces his retirement on Australia's premier current affairs program

All these factors are likely to weigh against Morrison's, the RBA's, and APRA's best efforts to reflate the Australian Housing Bubble.

Figure 16:Let's rename the Australian Prudential Regulation Authority as the Australian Ponzi Reinforcement Authority

Household credit is therefore likely to turn negative, something that has not happened in Australia since WWII—not even during "The Recession We Had To Have". Though business credit is currently rising, business debt is unlikely to rise much above its current levels, given the trend in business debt to max out at about 80% of GDP (see Figure 17).

Figure 17: Australian private debt by sector

Given how pro-cyclical business credit is—it tends to rise during booms and fall during slumps—it's more likely that business credit will also turn negative, thus giving Australia the double-whammy it avoided during both the Keating recession and the GFC (see Figure 18). This will finally break from the trend of rising private debt to GDP, as the USA and many others did during the GFC (see Figure 12 and Table 2).

Figure 18: Positive household credit during the Keating recession counterbalanced strongly negative corporate credit.

The only factors that can counteract negative private sector credit, and thus avoid a recession, are an export boom, and a large government deficit. The former is unlikely: the days of rising export volumes are over now that the China Boom is over, and the US-China trade war is taking a toll on trade in general. Australia can also benefit from improving prices for its commodity exports, but these have already risen strongly since 2016. The terms of trade could keep improving, but they are already the second highest Australia has ever experienced (the highest being at the top of the China Boom in 2011). Salvation from overseas is unlikely.

This leaves one other avenue to boost aggregate demand: a much larger government sector deficit.

This in itself is not bad policy—in fact, as Modern Monetary Theory argues, and as I have argued as well, a government sector deficit creates an identical non-government sector surplus. But the political conversation in Australia is still dominated by the belief that government debt must be reduced; the mainstream media and economists obsess about the government debt ratio of 40% of GDP, completely ignoring the private debt ratio that is five times as high.

Figure 19: Private and Government Debt in Australia

Given that I expected a private sector credit crunch to occur during the term of the next government, I also expected government spending and its deficit to rise dramatically. Had this been under a Shorten Labor Government, I knew the Murdoch Press would hammer this mercilessly, arguing that this showed how irresponsible Labor was.

Now the same thing is likely to happen on Morrison' watch. How will the Murdoch Press spin it then? Probably by arguing, correctly, that the deficit was a necessary response to a strong fall in private sector spending.

However, this isn't the hymnal from which Morrison currently expects to sing. Instead, he and his colleagues think that they're going to return the budget to surplus—and they'll continue slashing government spending on everything except the sacred cows of housing subsidies and military spending to achieve that.

They'll also probably have to cope with a serious decline in the value of the dollar as the credit crunch bites—something which attenuates the impact of a domestic downturn, but which also undercuts the profitability of banks, who rely on foreign borrowing to provide much of the capital that underwrites their lending.

So an intractable decline in house prices, screaming Baby Boomer borrowers locked into resetting mortgage payments and negative equity, a credit crunch recession, currency devaluation and a banking sector that may well need rescuing… That's a Hospital Pass of bad economic news that I expected was coming Australia's way, whoever won the election.

If it had happened to Shorten, Labor's electoral prospects in Australia would have taken a fatal beating. If it happens to Morrison? Then maybe some of the conventional wisdoms that have dumbed down economic debate and policy in Australia will finally get shafted.

Yes, it will be a miserable few years of cuts to the ABC, climate change denialism as government policy, slashing social security, and making scapegoats out of refugees. But it will also probably be several years of watching the Liberals respond like headless chooks to economic circumstances that they neither expect nor understand. I'm going to break out the popcorn and watch the show.


This post is already too long and rather overdue, since the election is a week over already, so I'm stopping it here. If there are points that have you scratching your head, check out the posts on my Patreon page on Australia, and the dynamics of credit money. Some useful links include:

Why I'm voting Liberal, and why other progressives should too

The air in the Australian housing bubble is too much credit

Australia's Housing Bubble Pops

My talk to 1st European MMT conference: Monetary Reality Vs Myth

Can't we all be Swabian Housewives?

Is there a role for government in promoting private sector financial resilience?

All the above are publicly available. I'm working on a book on money which will cover these topics thoroughly, and the first draft is available to Patrons only:

Draft of "Keen on Money" for Patrons only

Ireland's crazy numbers

Figure 20: Ireland's crazy debt figures

Figure 21: Ireland's crazy credit data

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