The global debt bubble

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The global debt bubble

• Steve KeenUniversity of Western Sydney

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A booming economy

• Seventeen years of growth

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A booming economy

• Fifteen years of falling unemployment

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A booming economy

• And 43 years of debt rising faster than GDP

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Having the (borrowed) time of our lives

• Another look at the medium term trend

• Does that look sustainable to you?

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Asset Rich and Debt Poor

• Assets are rising too

• But not as fast as debt has risen

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Asset Rich and Debt Poor

• And housing assets have risen only because
  theyve become more expensive

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Volatile Prices Sluggish Output

• Additions to housing stock lower in 2004 than in
  1997

• We had a borrowing boom, not a building boom

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Volatile Prices Sluggish Output

• Which is why were having a rental crisis
• But even rents havent kept pace with debt
  servicing

• Apparent high value of assets illusory

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Volatile Prices Sluggish Output

• Houses more expensive simply because weve been
  willing to borrow more money to buy them
• Prices up 250 since 1996 mortgage debt up 520

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Whos having a housing bubble then?

• Australias house price bubble even bigger than
  USAs
• And still growing!

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Ponzi Households

• Lending for housing rose from 5-25 of GDP

• Proportion that financed construction fell from
  30 to under 10

• No wonder were having a rental crisis
• We didnt build (m)any houses!
• Whats driving the debt?

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Having the (borrowed) time of our lives

• Theres something systematic going on here

• And were not alone unfortunately

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Having the (borrowed) time of our lives

• Not for the first time in our history either

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The Ponzi Economy
And Our Generation?
Baby Boomers Follies?
1890s Depression
Great Depression
Melbourne Land Boom
Roaring Twenties
What comes next?
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The Ponzi Economy

• Correlation isnt causation, but

Clearly exponential process
Biggest bubble in our history

• Serious Depressions after previous two debt
  bubbles
• What can we expect after this one?
• According to RBA, theres nothing to worry about!

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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)

Heading to equilibrium??
Skip Model
Analysis, or wishful thinking?
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Another interpretation limitless lending

• Whos 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)

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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

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Money from nothing, but your cheques aint free

• Loan an asset of bank
• Simultaneously creates liability of money in
  firms 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 gt
  rD
• Third account needed to record this Bank Deposit
  BD

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Money from nothing, but your cheques aint free

• Full system is

Interest flows banklt?gtfirm
Wage flows firm?gtworkers
Interest flows bank?gtworkers
Consumption flows bank workers?gtfirms
New Money/Debt flows banklt?gtfirms
Debt repayment flows firms?gtbank
Reserve relending flows bank?gtfirms

• 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?

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Would you like a credit card with that?

• Surprise surprise!
• Bank income rises if
• Loans are repaid slowly (or not at all)
• Repaid money is recycled more quickly and
• More new money is created

• Lenders profits by extending more credit
• Structural reason for lenders creating rising
  debt
• What if they decide to change direction?

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Money from nothing, but your cheques aint free

• Credit Crunch
• Rate of money creation drops
• Repayment of loans increases
• Relending drops

• LoansAssets in circulation fall even without
  bankruptcy
• Credit-driven economic reversal

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Why do borrowers accept debt in the first place?

• Hyman Minskys 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

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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

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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

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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

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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

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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 constrain debt
  growth at some point
• Borrowers cease borrowing
• Lenders cause credit crunch

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The Ponzi Economy

• Rising debt in the economic drivers seat
• No influence on unemployment in the 60s
• Accounts for 90 of unemployment now

• What happens next?...

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Back in the USA

• USA Housing Bubble has clearly burst

House prices falling by more than 1 per month!
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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

May you live in interesting times...
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For more information
www.debdeflation.com/blogs
www.debunkingeconomics.com