debt levels more dangerous than inflation.

http://www.abc.net.au/worldtoday/content/2006/s1783919.htm

Economist says debt levels more dangerous than inflation.

The World Today - Wednesday, 8 November , 2006

ELEANOR HALL: One economist who's been measuring Australia's private debt with growing concern says the Reserve Bank has made a big mistake with today's rate rise.

Dr Steve Keene is Associate Professor of Economics and Finance at the University of Western Sydney, and he predicts that escalating levels of debt in Australia will push the economy into collapse within two years.

Dr Keene says the Reserve Bank is part of the problem, because it's focusing on inflation rather than this rising debt.

Professor Keene, should the Reserve Bank have raised rates today?

STEVE KEENE: No, it shouldn't. It was focussing on inflation when I think the far greater danger to the Australian economy now is the level of debt, particularly household debt.

The Reserve Bank has dropped the bundle of debt, because the rate of debt has been growing inexorably since the mid 1960s, and it's now reached levels which are simply critical.

ELEANOR HALL: Just how high is the level of private debt in Australia?

STEVE KEENE: The level of private debt is currently 145 per cent of the level of output, so 1.45 times as much as we produce.

Back in the 1950s, it was 20 per cent. So it's gone up by a factor of six. It's as though we've gone from having a wombat in the lounge room to an elephant in the lounge room.

ELEANOR HALL: But isn't it going to help reduce debt, if the Reserve Bank raises the price of that debt?

STEVE KEENE: No. This is one of the paradoxes, and one reason why I'm now biting my tongue for last time around, saying well, I think maybe they should raise rates because hopefully it will have that particular impact.

Taking a look at the numbers more carefully, as I've done my most recent debt report, it seems to be about a two-year lag. After the economy gets into a slump, then debt levels start to fall.

So you can actually be in a recession and debt levels are still rising, simply because of the momentum issue that's involved in debt. And, unfortunately, far too many people know what I'm talking about now.

If your income starts to fall, that doesn't mean your debt goes down with it, it means your debt continues to rise, and if you can't meet the interest payments, then they get capitalised onto what you currently owe.

So the debt can actually continue having momentum of growth well after the economy's started tanking it. And I have a feeling that certainly has been the case in Australia, and it's only being masked by the scale of the China boom, making it look like the economy's doing okay.

So I think this… with the Reserve whacking the brakes on now, they've whacked the brakes… the domestic car has already stopped.

ELEANOR HALL: You say the Reserve Bank's been ignoring this problem, but what should it have been doing about private debt?

STEVE KEENE: Well, this is one of the things which it has to really seriously reconsider how it does its policy, because if you look at the historical record, the level of debt has been growing exponentially, and literally exponentially, compared to the level of output, since the mid 1960s.

So whatever policies the bank has been following for the last 40 years have had no influence on the level of debt. And I think this blind spot is now… you can't afford to have that blind spot anymore when your debts are one-and-a-half times your income.

ELEANOR HALL: So are you saying the Reserve Bank shouldn't be looking so carefully at inflation?

STEVE KEENE: No, I think in fact inflation may turn out to be something we desperately want at some stage. And this isn't leftie hyperbole, this is the situation Japan found itself in after it got caught up in a debt crisis in the 1990s.

Japan had low inflation at the beginning of their crisis in 1990, and just to give people an idea of how big that crisis was, you had the index falling from 40,000 to 7,000 points. In stockmarket terms, that's a depression.

You then look at the economy itself, it spent 15 years in the doldrums. During that time, they tried to reduce the level of debt, and they actually tried to cause inflation, and they failed abjectly.

We could find ourselves in the same situation, desperately longing for what the bank is now currently trying to suppress.

ELEANOR HALL: So you're saying that instead of looking at limiting inflation, the Reserve Bank should be trying to raise it?

STEVE KEENE: I think it will find itself in that situation if it's actually successful in driving inflation out of the economy now.

And in some ways I think you've got the classic case of the Reserve Bank winning the last war.

If you take a look at the rate of inflation back in 1974, it was 17 per cent. Now it's 3.9.

Take a look at the level of debt at the same time, compared to the level of output. In 1974, debt was 45 per cent of GDP (Gross Domestic Product). It's now 145 per cent of GDP.

ELEANOR HALL: But you talk about depression in Japan. I mean, even though there are obviously pockets of real hardship in Australia right now, you know, we've got so many more Australians in employment, we've got booms in at least two states. Do you really think that a depression is likely in Australia any time soon?

STEVE KEENE: If we follow the path that Japan has, then yes I do, because exactly the same things were said in spades about Japan in 1989. So you can get to be absolutely going gangbusters, you hit a debt wall, and if it's as big as we've got now, you just don't get out of it without the help of things we're currently trying to get rid of, like inflation.

ELEANOR HALL: From your knowledge of the level of private debt in Australia, have you been surprised by the official figures on defaults and mortgagee sales, because they don't seem to be so worrying?

STEVE KEENE: I was surprised by those figures. It did look strange compared to what I saw about the data.

With levels of debt like we've got, with the price bubble that we had beforehand, and with the number of people who were encouraged to regard speculating on house prices in Sydney as being investing for their futures, I can't see how you can match off those levels of private debt against the ending of the housing bubble, and still the level of mortgagee sales look quite low to me. It just didn't seem to compute, basically.

And your show yesterday, about the number of… the proportion of sales which are actually mortgagee sales, but aren't being noted as such, that's more realistic, and that is extremely scary, because we've never had scales that high since the great depression.

ELEANOR HALL: So, from what you're saying, we are heading for economic breakdown…

STEVE KEENE: I believe we are.

ELEANOR HALL: Can we avoid it?

STEVE KEENE: No. I'm titling this 'the recession we can't avoid'.

Now, I would be delighted to be wrong, and I'm not making an econometric prediction. I am making a prediction based on looking at the data and the debt deflation coming our way.

ELEANOR HALL: But a recession we can't avoid - when?

STEVE KEENE: Well, that's the $64 million question. If I had to put a stab at it, I'd say about one to two years away.

ELEANOR HALL: And that's Dr Steve Keene, Associate Professor of Economics and Finance at the University of Western Sydney, with that dire prediction.