Australia's debt profile is unusual in the developed world. Government debt is low, mainly because of the China boom and Peter Costello's relative parsimony in good times. But household debt is the worst in the developed world, driven by the housing boom, which continues to be disturbing. If that boom goes into reverse it will affect everyone, including the SMSF investors who have invested in the major banks. A downturn in the property market will also mean a downturn in the banks, whose business is heavily skewed to mortgage lending.
The Australian paints a problematic picture:
"Household debt is equal to 130 per cent of GDP, according to analysis by Barclays chief economist Kieran Davies, compared with an average across the advanced world of 78 per cent.
Australia’s debt levels are going up at a time when those of other advanced nations are coming down and Mr Davies said the Reserve Bank’s new round of rate cuts was likely to push the level of household leverage even higher.
Reserve Bank governor Glenn Stevens warned households last year against taking on excessive debt, saying leverage was already very high and “we would surely be asking for trouble if we see a big step up from where we are”.
Household debt was at 116 per cent of GDP before the financial crisis. It held steady until 2013, when the boom in investment property set it rising again.
“The tricky thing for the Reserve Bank is that promoting leverage is the key channel for the transmission of lower interest rates through to the rest of the economy,” Mr Davies said."
Debt accumulation is very much a matter of timing. Increasing government debt now, at a time when interest rates are at extremely low levels, makes sense. The time to fret over government debt is when the economy is doing very well. When economies are weakening, as the Australian economy is now, government deficits are more defensible.
But the opposite applies to private debt. The time to worry about it is when the economy is doing badly, because it is more likely that the borrower will struggle to meet the interest payments, especially if they lose their job. There is certainly a vulnerability:
Not only is household debt higher here than elsewhere, it is also higher now than at any time in Australia’s history. The level of bank lending as a share of GDP can be traced back to the 1850s and the level now is more than double the share of the previous peak, during the 1890s land boom.
“With high levels of leverage by world standards, where debt is concentrated in the household sector, we see this as a vulnerability in the event of another global shock,” Mr Davies said.
The level of household debt in Australia is inflated by the much greater popularity of real estate as an investment than in other countries, fostered by the ready availability of negative gearing tax concessions and favourable capital gains tax treatment.
Mr Davies said the banking regulator, the Australian Prudential Regulation Authority, was likely to impose new regulatory measures on lenders to curb the growth of investment property loans. In collaboration with the Reserve Bank, APRA imposed limits last year on the rate at which investment property loan portfolios could rise. Mr Davies said APRA could impose an additional capital charge on all investment property loans.
While households have been increasing their debt, companies have been cutting back. Among advanced countries, only 25 per cent have companies with less debt than in Australia.
Australian companies had debts equivalent to 84 per cent of GDP before the financial crisis. They had cut it to 67 per cent by 2011, but it has since crept back to 76 per cent. This compares with a world average of 106 per cent.
Mr Davies said the low level of debt reflected the fact that the resource companies had been able to finance much of their expansion from retained earnings, while investment levels in the rest of the economy had been extremely weak.
However, combined private-sector debt of households and business is still more than double the size of the economy, at 206 per cent of GDP. Mr Davies found that 75 per cent of advanced countries had smaller private-sector debt than that.
Although beyond the scope of his study of private-sector debt, Australia’s international standing as a borrower on world markets is helped by the low level of public-sector debt, which at 16 per cent of GDP is far below the advanced-country average of 74 per cent.
If there is one lesson since the GFC it is that government debt is much more damaging for an economy than private debt. Australia's low public debt is one reason why it survived the GFC relatively unscathed. The reason is that when private debt fails, in the first instance only the two parties are directly affected, whereas when government debt fails, the whole economy is potentially affected. There are repercussions of failing private debt, but they tend to be more dissipated than if governments are unable to meet their debt obligations.
So Australia's soaring private debt problems may have a more limited impact. But it is a concern.