The Problem is Private Debt, not Government Debt

The obsession on both sides of politics with cutting the Federal Government deficit is not only short sighted in the context of the recovery from recent floods.  It is also economically insupportable when private debt in Australia is more than twenty five times public debt.

It is hard to discern a clear reason for the obsession, beyond spruiking the virtues of thrift, or the idea that government borrowing crowds out private borrowing, or perhaps variations on the quaint old twin deficits theory that we used to hear about in the nineteen eighties.

The twin deficits theory is easy to dispose of. The claim was that a government deficit induced a (much larger) balance of payments deficit. Stephen Bell, in his 1997 book Ungoverning the Economy, plotted the two deficits from 1973 to 1994. There is no correlation whatsoever. Not that empirical falsification ever discouraged theoretical economists.

Part of the thinking behind the twin deficits theory was that government borrowing competes with private borrowing, so if the government borrows a lot it will tend to force interest rates to rise. That might make some sense if public borrowing was a large fraction of all borrowing. However economist Steve Keen has for some time been pointing out, using official data, that public borrowing is much smaller than private borrowing. Here is one of his revealing plots.

Australian Government debt and private debt

As you can see, currently public debt is around 6% of GDP.  Total private debt is hovering around 160% of GDP, about 26 times bigger.  Next is a breakdown of the debt:

Breakdown of private and public debts

The largest fraction of private debt is in the form of mortgages, which add up to almost 100% of GDP, whereas business debt is only around 60% of GDP.

Furthermore private debt has skyrocketed over the past decade, from around 100% of GDP to around 160% of GDP. The idea that reducing government debt by a few percent of GDP will make any difference to the economy is ludicrous in this context.

The third reason for obsessing about government debt, implied if not stated, is that thrift is a virtue. But why would thrift be urged so vociferously in this one area of Australian life when the siren call of debt is heeded by everyone, everywhere else?

The issue should not be government debt, but the use to which the debt is put. If the debt is used to build or restore infrastructure, it is a sound investment. The irony is that a great deal of the private debt is not for sound investment, but is frittered away on housing speculation and imported consumer goods. A shift to more government debt and less private debt would very likely improve investment in the productive economy.

So why do the Opposition and the mainstream commentators bang on so much about the supposed need to return the Budget to surplus? For Opposition Leader Tony Abbot it may simply be a convenient stick to thump the Government with, one that happens to act as a powerful dog whistle to the right-wing press. For those of right-wing persuasion, it may be a device to reduce Government, not just government spending. For economists of any persuasion, no credible reason seems to be evident.

Even more strange is that Labor takes the whole thing seriously, instead of just pointing out the pertinent numbers and laughing the issue out of court. However Labor runs scared on the whole issue of economic management. To take on the critics would take a little wit and a little courage. Ah, theres the rub, expecting wit or courage from a modern Labor Government, or a modern Labor Party.

The fuss should not be about government debt, it should be about dangerously high private debt. There are two related and compelling reasons for this, both of which Steve Keen and a few other lonely voices have been warning about for some time.

First, the greater part of the private debt is mortgage debt, which has increased rapidly, from about 20% to about 90% of GDP since 1990. Bankers and reserve bank bureaucrats deny there is a housing bubble in Australia, but the ratio of price to household disposable income has doubled since 1996:

Ratio of median established house price to income

The large mortgage debt will not generate any productive return. It has simply gone into inflating a housing bubble, which is the main reason for the ridiculous price of houses today. Demand may have temporarily outstripped supply (the fashionable reason) but much of the demand is for speculation, which will evaporate when prices stop increasing.

This brings us to the second and more dangerous problem with private debt, which is that we are still at risk of a major recession if the debt bubble pops. The problem is not just high debt, it is that debt has increased rapidly. In 2007 the net increase of private debt amounted to an astounding 20% of GDP. In other words the economy was not booming because of increased production but because we borrowed hundreds of billions of extra dollars. Without that increase in borrowing, the economy would have been in severe recession. We have been living beyond our means, and running up the collective credit card.

The great danger is in the fact that debt bubbles usually dont deflate slowly. The bubble is inflated by speculation and panic buying (if we dont buy now well never be able to) combined with loose lending practices. If prices start to decrease, the speculators want to bail out, which drives the price down faster, generating a vicious spiral. This happened in the United States subprime mortgage crisis, which triggered the global financial crisis.

As prices drop, available credit suddenly shrinks, so less money circulates and the economy slows. Just as the economy boomed when everyone was happily borrowing and spending, so it busts when the money supply shrinks and people reduce their discretionary spending to focus on paying down their debts.

The fact is that Australia’s economy has been grossly mismanaged by successive treasurers. The economy has prospered on a mining boom and easy credit. The proceeds of the mining boom have been frittered away on consumer goods and speculation. Too little has been invested in the productive economy. The grasshoppers summer may be coming to an end. The wisdom of the industrious ant may soon be forced upon us.

8 thoughts on “The Problem is Private Debt, not Government Debt

  1. Pingback: » Blog Archive » The Problem is Private Debt, not Government Debt | Better Nature …

  2. Kevin Cox

    Geoff as you say it is not debt that is important it is what we do with it that is critical. The underlying structural problem with our system is that we can only get credit if we have existing assets. The reason for giving loans is not to create new productive capacity but to protect the money lent. This is sensible if the loans are created to purchase existing assets but it is stupid if the loans are used to create new productive assets.

    We can fix the problem by issuing interest free loans to the general population as long as they agree to invest the loans to create new productive assets. It is quite easy to arrange this and issuing interest free loans to create renewable energy assets or to save energy is a guaranteed way of creating productive loans that will return more than is invested – provided the loans are interest free.

    This will stop the need for the banks to encourage the inflation of existing assets – particularly housing – in order to get loans flowing.


  3. Geoff Davies Post author

    Thanks Kevin, it’s a key distinction. If I may restate it a bit, the reason for requiring security on “loans” (even those that are 90% or more new money) is to protect the money lent/issued.

    If all you do is issue new money, you don’t necessarily require a claim over an asset to secure it. However I would argue you still want to require the money to be paid back/de-issued, because that completes the implicit social contract of spending/issuing money: if I give you a piece of paper (effectively an IOU) in return for goods or services, I am undertaking to return goods or services to the community, at which time I will receive the/an IOU back and the obligation is discharged. If, instead of returning goods or services, I just obtain more money and issue it, I’m getting other people’s stuff for free.

    For small amounts for daily living little or no security is required. For larger amounts I think some security would be required. Better yet, don’t create new money (which creates debt), use savings so there’s no new debt.

    When you suggest interest-free loans for new assets, you seem to mean issuing new money (not savings, so it’s not a loan). Perhaps I finally get why you advocate “interest-free” loans. If it’s new money, no return is due to a lender who is doing without savings. (I would argue an administrative fee is OK, but that doesn’t have the same baleful effects as charging interest.)

    Would it help your cause to talk about issuing new (tagged) money, on which interest need not be charged? That makes immediate sense to me, whereas just talking about interest-free loans only sounds like a subsidy applied within the present system, not a basically different form of money.


  4. Kevin Cox


    I am only talking about interest free money for new assets. I agree that we have to make sure loans are repaid and we do that by ensuring the money is invested in ways that will return more money than is loaned. The advantage of this approach is that we can leave the existing system in place and it will stop the explosion of debt in its tracks. The reason is that will be unprofitable for banks to create extra money because all their debt has interest attached. This means we will move to a 100% fractional reserve system where banks use existing money tokens to give loans secured against existing assets.

    The obvious place to give interest free loans is for renewables because without interest and with repayments spread over the life time of the assets then almost all renewables are profitable at today’s prices.

    The big advantage of this approach is that we do not have to modify the existing system which is going to be very very hard to change.


    We do this with HECS although I understand that there is now a small interest payment that matches inflation. There are many ways to do it and anyone with a lot of cash (like a super fund) could go to a bank and persuade the bank to

    Take the cash and lend it at interest eight times over.
    Give interest free loans to the super funds contributers to invest in renewable energy systems.
    The depositor agrees not to take the money out of the bank for the length of the interest free loans.

    If a government put up the cash then I would favour giving the interest free loans to those who consume the least amount of mains electricity and require them to invest the money in renewables.

    Have a look at this description that explains the solution by considering the issuing of credit as a tragedy of the commons and indicates “the solution”.

    There is


  5. graemebird

    The current Australian economics profession is divided into two camps. Neoclassicals and Keynesians.

    The neoclassicals appear to be apologists for the fractional reserve bankers and they never seem to see private debt that they don’t like. This goes to such an extreme as seeming to want to attach debt on all the good things. So they don’t kick up a stink when Queensland rail is set to be sold off on ghastly cronyist terms with Merryl Lynch and Rothschilds as the advisors.

    Merryl Lynch are welfare recipients who ought to be broke. The market spoke and they were to be wound up in 2008. Rothschilds are legendary intriguers. We would be better off if we excluded their non-Australian executives from our shores on character grounds. Because the advice they gave the Queenslanders was so very bad and its just depressing to see public policy failures on such a gargantuan scale.

    The neoclassicals will encourage debt on anything good if they have their way. You name it. Rivers to be privatised. Fishing rights to be handballed onto some giant corporation. Pretend friends of free enterprise; they see communist nationalisation of our strategic goods and they call it “free trade.”

    Now contrast this to the Keynesians. They are people who never see public debt that they don’t like. Ought we not reject both camps as servers of the idea of long-term bondage? After all its public debt which leads to us selling the farm and silverware down the track. One camp enables the other.

    The two schools of thought I would consider to be based on reason are the British Classical School and the Austrian School. The best living economist I consider to be George Reisman. Reisman is a minarchist and the Austrians are minarchists and anarcho-capitalists (following Rothbard).

    But one can be a hardcore crusader for rich biodiversity and still appreciate the technical proficiency of all these right-wingers. One can have a strong egalitarian bias, hate big corporatism, love small business and family farms …… and still acknowledge that these fellows are the best game in town as far as economic science is concerned.

    In fact price theory tells us that we really don’t need these huge companies to co-ordinate resource allocation. That would seem to be one of the big conclusions of price theory. Little and medium sized farms and companies will do just fine. And in this context we can have good buy-back provisions to start fleshing out nature corridors, and we can have the sort of incentives in place that would lead to the development of many new small family farms, carved out of the land now owned by giant agri-business.

    Don’t let the right-wing nature of some of these fringe economics characters put you off. The point is to have the knowledge to carve out the sort of community we ought to be able to deserve one day.

    I would certainly agree with much of what seems to be Geoff Davies overall project.

    Then there is Henry George. His perspective has to be met halfway, or part of the way. I think its a mistake to be absolutist either way with Henry George. The Labor party began as a Georgist party I think.


  6. graemebird

    “We can fix the problem by issuing interest free loans to the general population as long as they agree to invest the loans to create new productive assets.”

    A government could fund interest free loans to indnviduals if the agent had to make the loans such that they pushed up the tax that the person was paying. The extra PAYE would be considered interest paid. A wealth creating loan is one that improves cash flow.

    Which goes to show how this orgy of debt is hollowing out the middle class. Since the borrower, even if the loan is successful on cash flow grounds, leads to a draining of the borrower, both from a tax and interest point of view.

    The misallocation of resources by our private banks in the last 40 odd years has been astonishing. Lending has been for frippery and for the purpose of jacking up land prices.

    The average person, but worse still the average economist, does not seem to have any idea of the scale of the wealth destruction involved.


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