Always look on the bright side of debt

One might hope that the RBA would take this historical precedent to heart - and in at least one sense, it has. The problems of the 1890s were compounded by laissez faire regulatory practices that allowed many over-extended banks and pseudo-banks to fail, taking their depositor accounts with them. That didn't happen during the Great Depression, and the Reserve's swift actions when the subprime crisis began two months ago shows that it will act to prevent financial collapses today.

But in other respects, Battellino's speech had a "crisis? what crisis?" ring to it. Though he had the long term parallels at hand, he chose not to look at them, but instead concentrated on the demographics of debt today. He took heart from the fact that most debt is held by wealthier, older households, who presumably have the capacity to service the debt out of income.

However, the same would have been true in the 1880s - after all, only the wealthy (and especially the older wealthy) have the idle money and apparent assets needed to kick start speculation. The poor are, by definition, poor, and are normally too busy ensuring survival.

Nonetheless, Battellino argued that, even though the current debt ratio is 50 per cent above any previous peak, it is still below some hypothetical long-term equilibrium level:

"I don’t think anybody knows what the sustainable level of gearing is for the household sector in aggregate, but given that there are still large sections of the household sector with no debt, it is likely to be higher than current levels...
Eventually, household debt will reach a point where it is in some form of equilibrium relative to GDP or income, but the evidence suggests that this point is higher than current levels."

I hope these comments were an attempt to "not scare the horses", rather than a serious consideration of the current data and its historical precedents. What I see in the above graph is not a climb towards equilibrium, but a speculative bubble that has well overshot any equilibrium, and will inevitably have a downside. Debt will fall, but at the expense of a serious contraction in aggregate demand.

I just hope that, public utterances like Battellino's paper aside, the RBA is ready to cushion the blow when the debt bubble finally bursts.

See also Steve Keen's article: Deeper in Debt