Last week the opposition has rolled out the “debt truck” to add to the hysteria about growing government debt … the subject urgently needs a little perspective.
I have written on my stubbonrmule blog about 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!
Figure 1 – Australian Government Debt (1911-2008)
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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.
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!
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.
*This article first appeared in full at A Stubborn Mule’s Perspective