Examining explosive growth in debt ratios

Growth of debt has surged in developed nations in the past 30 years. Now similar growth is occurring throughout the developing world, especially the leading new developers such as China, India, Russia and Brazil.

As previously reported, in recent years growth of global money (and credit) in the developing nations has greatly exceeded that in the developed nations. This growth has fed the massive asset boom we are enjoying so much now.

For a group of 16 developed nations, including Australia, the "debt ratio" - the ratio of debt to GDP - has risen since the mid-1970s from about 60 per cent to 130 per cent.

Over the same period, Australian debt has risen from less than 50 per cent of GDP to about 160 per cent.

We are grateful to Reserve Bank deputy-governor Ric Battellino and The Economist for presenting these facts. Battellino has gone further and shown some long-term data for Australia from the middle of the 19th century.

During this long period, the debt ratio rose from 30 per cent to almost 75 per cent in the boom of the 1880s, then fell back to a bit more than 25 per cent, after which it rose again to almost 50 per cent in the boom of the 1920s. Now, after super-exponential growth in the past 30 years, the debt ratio is close to 160 per cent and still rising.

The explosion of debt in the past 30 years is mainly due to an orgy of lending to households.

Battellino says that "deregulation, innovation and lower inflation have simultaneously increased the supply, and reduced the cost, of finance to households", which have responded by using it on a far greater scale.

This is the overt message of Battellino's talk. The explosive growth of debt ratios is all about consenting adults optimising their portfolios.

The US sub-prime fiasco is about overlending by financial institutions and overborrowing by people who mostly cannot afford the debt they have acquired. Australians, it seems, are more careful, or perhaps this is an example of the US leading edge (of financial innovation) turning into the bleeding edge.

The ripples from the US sub-prime crisis have spread widely. Parcels of dud loans have been passed from investor to investor, and end holders have not always been at all sure of what is in their parcels. This uncertainty has spooked markets and in Britain there was an ugly run on a mortgage bank, Northern Rock, which greatly embarrassed the Bank of England and was quelled only by a hasty government guarantee of its deposits.

The big fear is that the crisis is far from over. Many sub-prime loans have yet to have their interest rates "reset" from below market (in many cases zero) to well above market (to compensate for the initial concession and the theoretical risk of default). The "reset" effect is expected to peak in early 2008.