FYI | Nov 29 2017
By Peter Switzer, Switzer Super Report
Last week the OECD looked at countries with high debt-to-GDP ratios and Canada was shown to be the worst! Wait a minute, I thought we owned that title, so maybe we can stop worrying that this might one day be our black swan.
Sorry, but this study, inexplicably left us out or the journalist from CNBC didn’t know we existed!
Canada’s number is 101% but this chart shows how we’ve topped them.
Yep, we beat these guys but I will note it was high after the GFC and has been above 100% since about 2005. And we coped with the GFC (with all our borrowed money from overseas bankers) with no recession and unemployment not piercing the 6% level. That might be true but the next global downturn could bring a different result for the world’s most addicted country to real estate.
I keep arguing if the GDP grows over 3%, as the RBA predicts, then the ratio of debt-to-GDP can fall. In fact, in recent times, the trend has started to fall. This chart here shows that pretty clearly.
The fear is a global recession or a financial crisis could result in global interest rates rising and we’d be caught out over-borrowed and seeing our house prices falling. This would KO consumer confidence and be a precursor to a recession.
Shane Oliver, my old mate at AMP Capital, recently summed up the housing concerns. “A common narrative on the Australian housing market is that it’s in a giant speculative bubble propelled by tax breaks, low interest rates and “liar loans” that have led to massive mortgage stress and that it’s all about to go bust, bringing down the banks and the economy with it,” he wrote. “Recent signs of price falls – notably in Sydney – have added interest to such a view.”
He expects Sydney and Melbourne to have 5-10% corrections in house prices in the not-too-distant future but he’s not seeing Armageddon in his crystal ball. And that is in part due to the fact that he’s not mesmerized by our household debt-to-GDP numbers.
Let’s see why.
Debt is always at the heart of all economically scary stories. If it’s not us, it’s China or the world, where total debt has topped $US200 trillion dollars! Who hasn’t heard “we’re living beyond our means” and “the day of reckoning is coming”?
But let’s get some facts on the matter.
Shane says: “Excluding the debt of financial companies like banks (to avoid double counting), total gross world public and private debt is around $US170 trillion.”
But dollars mean little unless you want to scare people, so let’s look at it in GDP terms and gross world public and private non-financial debt rising to a record of 235% of global GDP. A lot of this rise has been public debt, as governments fought a potential Great Depression.
The data below puts Australia into a global context when it comes to debt.
While Japan is the worst when it comes to total debt-to-GDP (at 250% of GDP for public debt and 66% for households), the USA has public debt at 108% of GDP, while household debt is 78%.
Australia is the 16th lowest out of the 23 countries looked at but our household debt to GDP was 125%, Denmark was 123% and Canada was 98%.
Shane says, “Australia does not rank highly in total debt – it has very high household debt but it’s offset by low public and corporate debt.”
We are vulnerable to rising interest rates or a black swan event that pushed up rates, but how likely is that? And anyway, how bad will the experience be, given our GFC story of unemployment not even beating 6%?
Shane also argues that debt that begets investment and economic growth can be virtuous and is a positive input into a bigger economy.
For those worried about Chinese debt, this is his important point.
“China has led the surge higher in private debt in recent years but… it borrows from itself” and critically the expansion of productive assets there reduces the worries about their debt. The Chinese saving ratio is a huge 50%, so move on.
Next, debt interest burdens are low and, in many cases, still falling, as more expensive long maturity older debt rolls off. For example, despite the recent rise in bond yields, US public debt interest payments are less than 3% of US GDP – well down from 4.5% in 1991. These long-dated bonds mean the next refinancing rounds will be a way off.
This is all relatively comforting but this is the Oliver revelation I like the most: “In Australia, interest payments as a share of household disposable income are at their lowest since 2003, and are down by more than a third from their 2008 high.”
In the chart below, the blue line is more scary than the red one, which shows how our debt-servicing situation has improved, thanks to our low interest rates, even though they are some of the highest in the world!
What about public debt? This is Shane’s take: “Most of the debt increase in recent years in developed countries has come from public debt and governments can tax and print if worse comes to worse,” he explained. “Japan is perhaps most at risk here, given its very high level of public debt but it has borrowed from itself and Japan remains one of the world’s biggest creditor nations.”
Next, what if interest rates rise too quickly? Well, we know central banks are not falling over themselves to do that, so it would only happen if a black swan event chokes the global financial system. Most of us can’t see black swans but we can see improving economic forecasts and better economic data, which I said earlier reduces things like debt-to-GDP ratios.
By the way, Shane is not doing an ostrich act with his head in the sand, as the following shows: “History tells us that the next major crisis will involve debt problems of some sort. But just because global debt is at record levels and that global bond yields have moved higher does not mean a crisis is imminent.”
On property crashes, Shane uses history to allay our fears.
The trouble is, we have been hearing the same for years, he argues. “Calls for a property crash have been pumped out repeatedly since early last decade. “In 2004, The Economist magazine described Australia as “America’s ugly sister,” thanks in part to a borrowing binge and soaring property prices. At the time, the OECD estimated Australian housing was 51.8% overvalued. Property crash calls were wheeled out repeatedly after the Global Financial Crisis (GFC), with one commentator losing a high-profile bet that prices could fall up to 40% and having to walk to the summit of Mount Kosciuszko as a result. In 2010, The Philadelphia Trumpet (a US newspaper) warned ‘Pay close attention Australia. Los Angelification (referring to a 40% slump in LA home prices around the GFC) is coming to a city near you.’
At the same time, a US fund manager was labelling Australian housing as a ‘time bomb’. Similar calls were made last year by a hedge fund researcher and a hedge fund: ‘The Australian property market is on the verge of blowing up on a spectacular scale…The feed-through effects will be immense… the economy will go into recession.’ Over the years, these crash calls have even made it on to 60 Minutes and Four Corners.”
But still we survive!
Shane argues that the conditions for a crash are not in place.
“To get a housing crash – say a 20% average fall or more – we probably need much higher unemployment, much higher interest rates and/or a big oversupply. But it’s hard to see these.”
Interestingly, the chart below shows that even with our booming Sydney and Melbourne markets, we’re not much above our long-term trend for real home prices.
My strongest argument for stocks’ optimism is the improving economic outlook, which both Goldman Sachs and Macquarie Bank both gave the thumbs up for 2018. When the economic story worries me or I see something that looks a little like a black swan, you’ll be the first to know.
Peter Switzer is the founder and publisher of the Switzer Super Report, a newsletter and website that offers advice, information and education to help you grow your DIY super.
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