Download and debt

The global debt bubble
Steve Keen
University of Western Sydney
A booming economy…
• Seventeen years of growth…
Economic Growth
6
5
4
Percent
3
2
1
0
Change in Real GDP
Hewson Loses
Howard Wins
1
2
1992
1994
1996
1998
2000
2002
2004
2006
2008
A booming economy…
• Fifteen years of falling unemployment…
Unemployment
12
Unemployment
Hewson Loses
Howard Wins
11
10
Percent
9
8
7
6
5
4
1992
1994
1996
1998
2000
2002
2004
2006
2008
A booming economy…
• And 43 years of debt rising faster than GDP…
Debt and Nominal GDP
2000000
1800000
1600000
$ Millions
1400000
1200000
Debt
GDP
Menzies 49-72
Whitlam 72-75
Fraser 75-83
Hawke 83-96
Hewson
Howard 96-07?
1000000
800000
600000
400000
200000
0
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
Having the (borrowed) time of our lives…
• Another look at the medium term trend…
Debt and Nominal GDP
7
110
$ Millions
1000000
Debt
GDP
Menzies 49-72
Whitlam 72-75
Fraser 75-83
Hawke 83-96
Hewson
Howard 96-07?
100000
• Does that
look
sustainable
to you?
10000
1000
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
Asset Rich and Debt Poor…
• Assets are rising too…
Household Assets and Liabilities
6000000
• But not as
fast as
debt has
risen…
Assets
Liabilities
Net Position
$ Million
4000000
2000000
0
1990
1995
2000
2005
Asset Rich and Debt Poor…
House Prices and Mortgage Debt
40
House Price Index
Mortgage Debt
Annual percentage change
30
20
10
0
 10
1990
1995
2000
2005
• And housing
assets have
risen only
because
they’ve
become more
expensive…
Volatile Prices & Sluggish Output
• Additions to housing stock lower in 2004 than in 1997…
Changes in Housing Stock
Price
Quantity
Percent
20
10
0
1998
2000
2002
2004
• We had a borrowing boom, not a building boom…
Volatile Prices & Sluggish Output
• Which is why we’re having a rental crisis…
• But even rents haven’t kept pace with debt servicing:
Rental income versus mortgage interest
Current $ million
80000
60000
40000
Rental Income
Interest Payments
Gap (RHS)
30000
40000
20000
20000
10000
0
1980
1990
2000
0
• Apparent
high value
of assets
illusory
Volatile Prices & Sluggish Output
• Houses more expensive simply because we’ve been willing
to borrow more money to buy them…
– Prices up 250% since 1996; mortgage debt up 520%
Dwelling Price & Value vs Mortgage Debt
600
Indeces (1996=100)
Value of Housing
Price of Housing
Mortgage Debt
400
200
0
2000
2005
Who’s having a housing bubble then?
• Australia’s house price bubble even bigger than USA’s
• And still growing!
US & Australian House Prices
300
250
Index
200
150
100
50
USA (Case-Schiller)
Australia (ABS 641601, 641603)
0
1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
Ponzi Households
• Lending for housing rose from 5-25% of GDP:
Aggregate New Lending for Housing
Housing Construction
25
15
10
5
Percent of Total Lending
Percent of GDP
20
70
60
Owner Occupiers
Investors
50
40
30
20
10
0
1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
0
1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
• No wonder we’re having a
• Proportion that financed
rental crisis…
construction fell from 30%
to under 10%:
– We didn’t build (m)any
houses!
• What’s driving the debt?
Having the (borrowed) time of our lives…
• There’s something systematic going on here…
Debt and Politics
160
Percent of nominal GDP
140
120
100
Debt Ratio
Trend from 64
Menzies 49-72
Whitlam 72-75
Fraser 75-83
Hawke 83-96
Hewson
Howard 96-07?
80
60
40
20
1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
• And we’re not alone… unfortunately
Having the (borrowed) time of our lives…
Household Debt to GDP
100
Percent
80
USA
Australia
1990+ trend 2.1%
1990+ trend 6.8%
60
40
20
0
1960
1980
2000
Date
• Not for the first time in our history either…
The Ponzi Economy
Debt to GDP: The Long Term View
160
Percent of nominal GDP
140
120
Debt Ratio
Trend 1964-Now
Trend 1880-1892
Trend 1925-1932
100
80
60
40
20
0
1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
The Ponzi Economy
• Correlation isn’t causation, but…
0
T
1
2
3
0
"Variable"
"Credit"
"Credit"
"Credit"
1
"Compared to"
"GDP"
"GDP"
"GDP"
2
"Start Date"
1880
1925
1964.5
3
"End Date"
1892.5
1932
2007.7
4
"Growth Rate"
9.2
9.5
4.2
5
"Correlation %"
6
"Doubling Period"
7.5
7.3
16.6
7
"Duration"
12.5
7
43.2
8
"Initial Value"
33.9
40.3
24.7
9
"Final Value"
103.9
76.2
159.5
10
Clearly exponential
process
97.9
97.6
Biggest bubble
in our history
"Increase %"
206.5
88.8
99.1
546.9
• Serious Depressions after previous two debt bubbles
• What can we expect after this one?
• According to RBA, there’s nothing to worry about!…
Efficient markets & financial democracy?
• Ric Battellino, Deputy Governor, RBA:
– “Has the expansion of household credit run its course?
Will it reverse? We cannot know the answer to these
questions with any certainty, but my guess is that the
democratisation of finance which has underpinned this
rise in household debt probably has not yet run its
course...”
– “Eventually, household debt will reach a point where it
is in some form of equilibrium relative to GDP or
income, but the evidence suggests that this point is
higher than current levels.”
• (Battellino, “Some Observations on Financial
Trends”, 25 September 2007)
Skip Model
Another interpretation: limitless lending
• Who’s in control of the money supply and debt?
– Economics textbooks
• The Government/Central Bank
– Central Bank creates “base money”
– Sets “money multiplier”
– Credit Money = Base Money * Credit Money
– Economic data
• “There is no evidence that either the monetary
base … leads the cycle, although some economists
still believe this monetary myth.
• … the monetary base lags the cycle slightly…
• The difference of M2-M1 leads the cycle by …
about three quarters.” (Kydland & Prescott 1990, p.
15)
The new monetary paradigm
• Money supply “endogenous”
– Credit money not under government control
• Inherent bias towards providing as much debt as can flog
• How does it work? Simple!
– Consider bank loan of $L to Firm
– Simultaneously creates Deposit $L and Loan $L
– Charges rL% p.a. on loan
– Pays rD% p.a. on deposit
– And so on…
• Put together flows & you can understand credit creation
– Starting from the beginning
• Loan by bank created both money and debt…
“Money from nothing, but your cheques ain’t free”
• Loan an asset of bank
• Simultaneously creates liability of money in firm’s deposit
account:
• Sets off series of obligations:
– Interest charged on loan at rL% p.a.
– Interest paid on deposit at rD% p.a. where rL > rD
– Third account needed to record this: Bank Deposit BD
“Money from nothing, but your cheques ain’t free”
• Full system is:
Interest flows: bank<―>firm
Wage flows: firm―>workers
Interest flows: bank―>workers
Consumption flows: bank & workers―>firms
New Money/Debt flows: bank<―>firms
Debt repayment flows: firms―>bank
Reserve relending flows: bank―>firms
• Table describes self-sustaining pure credit economy
• Can now ask “What happens to bank income if…”
– New money created more quickly
– Loans repaid more quickly
– Reserves re-lent more quickly?
“Would you like a credit card with that?”
• Surprise surprise!
12
• Bank income rises if
– Loans are repaid slowly10
(or not at all)
8
– Repaid money is
recycled more quickly;
and
6
– More new money is
4
created
2
Bank Net Income and Bank Parameters
Standard
New Money
Loan Repayment
Recycling Loans
0
2
4
6
8
• Lenders profits by extending more credit…
– Structural reason for lenders creating rising debt
– What if they decide to change direction?
10
200
“Money from nothing, but your cheques ain’t free”
• “Credit Crunch”:
– Rate of money creation drops
– Repayment of loans increases
– Relending drops…
100
0
300
0
5
5
10
15
10
15
15
Firm Loan
Bank Reserve
Firm Deposit
Worker Deposit
Bank Deposit
Assets
Bank Reserves
Firm Loan
300
200
10
200
100
5
100
0
0
5
10
15
0
0
0
5
• Loans—Assets in circulation fall even without bankruptcy
Assets
Bank Reserves
• Credit-driven
economic reversal…
Firm Loan
300
10
0
Why do borrowers accept debt in the first place?
• Hyman Minsky’s “Financial Instability Hypothesis”
– An explanation for debt-driven booms & depressions
• Economy in historical time
• Debt-induced recession in recent past
• Firms and banks conservative re debt/equity ratios,
asset valuation
• Only conservative projects are funded
• Recovery means conservative projects succeed
• Firms and banks revise risk premiums
– Accepted debt/equity ratio rises
– Assets revalued upwards
The Euphoric Economy
• Self-fulfilling expectations
– Decline in risk aversion causes increase in investment
• Investment causes economy to grow faster
– Asset prices rise
• Speculation on assets becomes profitable
– Increased willingness to lend increases money supply
• Credit money endogenous
– Riskier investments enabled, more asset speculation
• Emergence of “Ponzi” financiers
– Cash flow always less than debt servicing costs
– Profits made by selling assets on a rising market
– Interest-rate insensitive demand for finance
The Assets Boom and Bust
• Initial profitability of asset speculation:
– reduces debt and interest rate sensitivity
– drives up supply of and demand for finance
– market interest rates rise
• But eventually:
– rising interest rates make many once conservative
projects speculative
– forces non-Ponzi investors to attempt to sell assets to
service debts
– entry of new sellers floods asset markets
– rising trend of asset prices falters or reverses
Crisis and Aftermath
• Ponzi financiers go bankrupt:
– can no longer sell assets for a profit
– debt servicing on assets far exceeds cash flows
• Asset prices collapse, drastically increasing debt/equity
ratios
• Endogenous expansion of money supply reverses
• Investment evaporates; economic growth slows or
reverses
• Economy enters a debt-induced recession ...
• High Inflation?
– Debts repaid by rising price level
– Economic growth remains low: Stagflation
– Renewal of cycle once debt levels reduced
Crisis and Aftermath
• Low Inflation?
– Debts cannot be repaid
– Chain of bankruptcy affects even non-speculative
businesses
– Economic activity remains suppressed: a Depression
• Big Government?
– Anti-cyclical spending and taxation of government
enables debts to be repaid
– Renewal of cycle once debt levels reduced
• Sounds like history lesson rather than economic theory…
Meanwhile, in the real world…
• Combination of record Debt/GDP, high nominal interest
rates and low inflation means huge real interest burden:
• Debt servicing
pressure will
15
constrain debt
growth at
10
some point
5
– Borrowers
cease
0
borrowing
5
– Lenders
cause credit
 10
1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
crunch…
Inflation-adjusted interest payment burden
Percent of GDP
20
The Ponzi Economy
• Rising debt in the economic driver’s seat
– No influence on unemployment in the 60s
– Accounts for 90% of unemployment now
Change in Debt, Politics, & Unemployment
Unemployment & Debt Contribution to Demand
16
14
12
Debt Change
Whitlam 72-75
Fraser 75-83
Hawke 83-96
Hewson
Howard 96-07?
Unemployment
10 10
9
0
 10
8
 20
7
10
8
6
 30
6
 40
5
 50
4
 60
4
3
 70
2
2
 80
0
1 90
2
1955 1960 1965
1970 1975 1980
1985 1990 1995
2000 2005
• What happens next?...
Unemployment
18
11 20
Percent
Percentage Contribution to Aggregate Demand
20
0 100
2010 1960
Correlation
Whitlam
Fraser
Hawke
1965
1970
1975
1980
1985
1990
1995
2000
Back in the USA…
• USA Housing Bubble has clearly burst:
Case-Schiller US Housing Index
250
3
200
Index
1
150
0
100
1
50
1990
1995
2000
2005
2
Index
Monthly Change
House prices falling by more than 1% per month!
Monthly Change Percent
2
In China we trust?…
• Macroeconomic link:
– Aggregate demand = GDP + change in debt
– As debt rises, dependence on change in debt has risen
• Now accounts for 18% of aggregate demand
• Even stabilising debt/GDP ratio will cause 5%+ cut in
spending
• Serious downturn inevitable
• Counter forces
– Possible global warming/peak oil inflation
• Inflation reduces debt burden
– China boom…
• We are entering stormy economic waters…
For more information…