Australian private debt is the big issue, not government debt

September 9, 2014

By Stephen Koukoulas

A huge amount of political capital has been invested and spent on the issue of government debt and deficit. Indeed, the Coalition’s use of propaganda surrounding government debt and deficit was a critical factor helping it to win the 2013 election.

Emotive phrases along the lines that current generations are borrowing from our children, or that by running a budget deficit today we leaving our kids with a debt legacy, strike a chord with an ill-informed electorate.

The fact that the Australian government has, in the past five years or so, accumulated a very modest level of net debt equal to around 13% of GDP is magnified by the anti-debt campaigners, even though the level heads in financial markets have pushed government bond yields to near record lows and share prices to a six-year high, and the credit ratings agencies are unanimous in rating Australia triple-A with a stable outlook.

What is almost always overlooked in the debt debate is what the money in question has been used for, and why private sector debt, which is many multiples of government debt, is not seen as a bad, economically irresponsible thing.

Recent data released by the Reserve Bank of Australia show that the private sector in Australia has bank debt totalling just under $2.3 trillion. There is a further $450bn or so in corporate bonds which companies borrow direct from fund managers. This overall level of private sector debt is around eight times the level of gross Commonwealth government debt.

Interestingly, the household sector share of this private debt is $1.525 trillion, something that has never been mentioned by the Coalition members who bemoaned the rise in Commonwealth government debt to $200bn when they were in Opposition.

It is not at all clear why there is a disconnect between government debt and private sector debt.

Both are usually allocated for productive purposes – housing and long-run investment – while some debt is raised to fund consumption.

When the private sector takes on debt to say, buy a house, the returns on those borrowings are instant – a roof over the head of your family, nice furniture and usually a pleasant lifestyle. The good news is that the lender, usually a bank, does a lot of due diligence and will not lend to you if you are a high credit risk, so the quality of that debt is usually very high. Over time, household incomes grow at about 4% per annum, well above the average inflation rate of 2.5%, which means the capacity to repay the debt increases with time.

For a government in Australia, debt is usually undertaken in periods of weak economic activity. The governments of Whitlam, Fraser, Hawke, Keating, Howard, Rudd and Gillard have all run budget deficits when confronted by periods of sub-trend economic growth and rising unemployment. The governments since Fraser have, on average, all framed budgets around a broad objective of budget balance over the course of the cycle.

It is important to realise that government debt is fungible, or freely exchangable. The money borrowed each week from the capital markets is not attached to a specific purpose such as covering road funding, your pension payment, running Parliament House, Medicare or anything else. It would be folly to have such an approach given these payments are erratic and are funded, in large part, from tax and other government revenue.

All the Australian Office of Financial Management does when it borrows money on behalf of the government is know what the aggregate funding task is and it has no interest what the money is being used for. It is the same story with those lending the government the money – the holders of government bonds. They do not say I will buy a bond but only if it is for funding a road and not if it is for buying a jet for the airforce.

Since Federation in 1901, the Commonwealth government has never defaulted on its debt, nor has it ever missed an interest payment to the holders of that debt. This emphatically shows that government debt is not and never has been a problem in Australia. A 100% debt repayment record for more than 100 years.

According to APRA data, even when the economic is performing well, around 1% of bank assets are “non-performing”, meaning that the borrower is very late in their repayments or they have in fact defaulted and will never pay back that money to the bank. During periods of weakness, this can rise above 5% which imposes an extraordinary cost to the economy and a handbrake on growth, unlike government debt.

It is pretty clear where the risk is in the issue of private and government sector debt.

It is just that you will never hear a Coalition member raise the issue of private sector when they have invested so much political capital in demonising government debt. This is despite the fact that the level of government debt and the servicing of that debt is one of the least risky parts of the Australian economy.