Join our investing community

Credit Contraction In Australia Begins - Very Ominous

Discussion in 'The Economy' started by Chris C, 6th Feb, 2009.

  1. Chris C

    Chris C Well-Known Member

    Joined:
    2nd Apr, 2008
    Posts:
    1,327
    Location:
    Brisbane, QLD
    For the last couple of months my biggest concern has been the level of credit in the market dropping, and it would appear that it is only now just starting to take hold:

    Lending shrinks for first time in 16 years - Local News - News - General - The Canberra Times

    RBA gets point with rates jolt

    I know in times like this everyone is told to pay down debt or spend, spend, spend, but the reality is that if the credit in the economy starts to significantly decline (which is for all intents and purposes the same as a money supply contraction) this is when asset prices are really going to start falling.

    My point is that it doesn't matter what the interest rates are, if people don't borrow money to buy houses then the price of houses are going to fall! Australia's housing boom over the past few years has been fueled by massive credit/debt expansion, for prices to be sustained we need to maintain that level of credit in the market, but at this stage it is looking less likely.

    I don't know what the solution is, but obviously aggressively dropping interest rates isn't doing enough right now to maintain credit levels, and whilst I can appreciate that credit levels do need to be reduced but we need to make sure they don't go into free fall.

    I should also point out that I'm not advocating that credit levels should be increased - they have far exceeded any rational level, but a quick contraction will be disastrous.

    I for one think that at the end of all this Australia should really look place some more aggressive regulations on the rate at which credit can grow within this country. By that I mean place tighter regulations on both the RBA and their ability to move interest rates and both the RBA's and private bank exploitation of fractional reserve banking. I mean people always talk about "the business cycle" like it is a natural phenomenon, but the reality is that it is a largely create phenomenon through both credit expansion and contraction which is exacerbated by the coming and going of consumer confidence.

    I think we should have interest rate targeting as much as inflation based targeting as inflation is just a by product of an increase in the quantity or velocity of the money supply. Placing a range on the cash rate of something like 4% - 6% should limit the scope for both expansion and contraction of the money supply, as thus inflation.

    This would need to be coupled with limitations being placed on fractional reserve banking, maybe setting a range where banks need to keep 33% - 20% reserves on credit loaned out. This policy would obviously have to be on that is phased in because it would greatly reduce the money supply in the system at present, which interestingly enough I can't find any data on... (I'm going to just assume that the current fraction reserve requirements are around the 10% mark, though I know a lot of international banks were lending at much lower reserves than that).

    These two amendments would greatly reduce both the RBA's and the private banks ability to influence the money supply. Obviously it isn't the best solution (destroy the RBA and create a government backed, debt free currency which grows at the rate of population growth) but I fear that a radical change is much more difficult to gain support for than minor change, and I think the tactful solution to this crisis is to boil the bankers slowing rather than throw them into boiling water where they may look to jump out and fight back.

    Anyone care to discuss the issue?
     
  2. shasta

    shasta Member

    Joined:
    23rd Aug, 2007
    Posts:
    23
    Location:
    Melbourne, Vic
    Hi Chris C

    I do respect a man that is willing to think about the tough issues, like designing a better monetary system etc. But with the luxury of reflecting on your comments, i'm not sure i agree.

    Dont know how to insert quote, but you said that credit is dropping. The RBA released today probably the most upto date and well respected piece on the global financial/economic crisis - their quarterly statement on monetary policy (Reserve Bank of Australia - Home Page). On the first page it notes that credit markets seem to be freeing up (in Australia) and that Aussie banks are issuing bonds with relative ease.

    I have mentioned before on this site that the RBA website is THE authoritive source on Marcoeco and associated moneraty policy. Read their stuff - they have freely accessible working papers, research papers, monetary policy statements and speeches. I dont like newspaper articles as sources, sorry.

    In addition you said:

    'I think we should have interest rate targeting as much as inflation based targeting as inflation is just a by product of an increase in the quantity or velocity of the money supply. Placing a range on the cash rate of something like 4% - 6% should limit the scope for both expansion and contraction of the money supply, as thus inflation.'

    Arent there other drivers of inflation? For example Terms of Trade - if the ToT rises then the effective 'income' and purchasing power of the economy rises and this would add to aggregate demand, raising demand pull inflation (ceterus paribus).

    Government spending (the G in GDP = C+I+G+NX) would also increase agg demand. So ithink your stylised model might need some work.

    But keep thinking. I dont have the answers!
    shasta
     
  3. Chris C

    Chris C Well-Known Member

    Joined:
    2nd Apr, 2008
    Posts:
    1,327
    Location:
    Brisbane, QLD
    Firstly, thanks for the response - I really appreciate good quality feedback, and it's good to get the discussion rolling. So in that spirit, I have some feedback of my own.

    I wasn't referring to the availability of credit, I was referring to the "level" of credit in the market, as in people are no longer borrowing money, they are paying down debt, which is essentially reducing the money supply when you take into account that most money supplies are significant multiples of physical money supply due to fractional reserve banking. However as people pay down their debt banks reserves are increasing.

    So those news articles I posted were not suggesting that credit markets were weakening, they were suggesting that people are no longer borrowing, aka credit expansion has stopped, which will ultimately mean asset price deflation. However with unemployment no doubt about to spike and there being a lot of uncertainty in the market, even if the RBA cash rate was at 0% I don't think you could get people to borrow at the moment.

    However, on the note of the increasing availability of credit (aka the unfreezing of credit markets) yes, there has be significant progress in unfreezing of international credit markets, though I remember reading an article recently that was actually showing that in the last few days, the markets have begun to tighten up again, no where near to the level when Lehmans collapsed, but still tighter markets is not what you want to see.

    I think there is a lot of fear emerging that this downturn is still far from over. I know there are a lot of rumours around Bank of America and its acquisition of Merrill Lynch, many are fearing that ML's bad debts may end up sinking BofA as well.

    Even in Australia is there is a whole lot of uncertainty at the moment, especially around Suncorp and Bank of Queensland. So I wouldn't be surprised if money markets really start to tighten up again.

    I'm with you on the lack of appreciation for newspaper articles, though I, like most, do peruse through them from time to time. I do occasionally read releases on the RBA, I probably should read more from them, but at the same time you should be wary of the RBA's reports. They are not as "independent" as you might think. They are a private institution and they are run "for profit" and pay no tax either!

    I'm not going to say they are unreliable, I'm just going to say I take everything from the RBA with a gain of salt, but I do the same for newspapers as well. Thus the reason I enjoy discussions on these forums - people don't have nearly as big a vested interested when it comes to chatting on a forum... whether that makes the discussion more valuable obviously is up for debate.

    :rolleyes:

    You are very right here, the fact we have an open economy really would leave us quite exposed to international influences. I guess my only counter argument to this point is that just because other countries continue to be run and regulate poorly doesn't mean we should, despite the hardships we might create for ourselves. To be completely honest, many international countries need good models to follow and we should be leading by example.

    Apparently only a few days agao Julia Gillard was at Davos showing off our financial institution regulations to the rest of the work as a model to be strived for, you'd hope that this turmoil would prompt those countries to look at the short coming of their systems, and they'd be willing to make changes. So, I guess my argument is that if you can lead the way it is much easier for other to follow.

    Also I wouldn't be against giving GOVERNMENT the ability to TEMPORAIRLY give the RBA the authority to breach the suggest bands in times of crisis and necessity, but I personally would like to see the decision out of the RBA's hands, and given to the almost equally unreliable authority of the government. Though I think this is a much better position that giving the RBA unregulated authority over our monetary policy.

    No doubt, I really just created this thread to throw a passing thought into the realm of active discussion, because I think this is where all good ideas start - on the drawing board.
     
  4. dudek

    dudek Well-Known Member

    Joined:
    10th Sep, 2008
    Posts:
    199
    Location:
    Sydney
    I understand it was Peter Costello who first introduced our system to US but they would not even look at it. I have much of the respect to Peter and lot of credit for today’s economic position should be paid to him. I am still waiting for this government to acknowledge his contribution.
     
  5. shasta

    shasta Member

    Joined:
    23rd Aug, 2007
    Posts:
    23
    Location:
    Melbourne, Vic
    Chris C

    I just re-read yours/my post and i did seem to miss the 'discussion starter' aspect to what you're saying, not to metion the credit level v's growth aspect.

    But you've definately piqued my interest with the RBA independence issue. I read/watched another post from another contributor that contained an old film on the US Fed - about their privatisation, motives etc.

    I must say, i dont buy it at all and i certainly dont think that the RBA is problematic, in any way. Keating (i think) played a part in creating a system of monetary policy independence. I think it works well. Point me to one occasion since the current RBA/monetary independence model was implemented where they have (based on the information they had available to them in real-time) made an even remotely dodgy interest rate move. Their job is to focus on containing inflation over the medium term. They do it quite well.

    If as a by-product they make some cash, so be it. But that is as an organisation - there aren't fat cats sitting around tapping into RBA accounts!!

    Jeepurs!

    By the way i dont and have never worked for them, in case your wondering.
     
  6. Chris C

    Chris C Well-Known Member

    Joined:
    2nd Apr, 2008
    Posts:
    1,327
    Location:
    Brisbane, QLD
    If you are referring to the Money Masters video, I have posted that a few times around these forums. I think the videos opens people's eyes to the "possibility" for exploitation via central banking systems. Unfortunately it is more difficult to find information about the RBA's shady activities as most central bank conspiracy theories center around the FED.

    My understanding was that Keating just floated the Australian dollar, he didn't have any major involvement with establishing the RBA.

    Inflation is simple to manage, simply don't change the money supply. That is why so many people advocate the use of gold as a means of currency because you can't inflate the availability of gold, though you can still increase the level of credit within an economy with the gold standard through fractional reserve banking. And whilst more gold is mined every year, the amount of gold added to the current world gold supply is very marginal, thus it would create a very low level of inflation that probably wouldn't even account for population growth.

    I should point out that I'm not advocating a gold standard because I do agree that there are some flaws to the gold standard. The point I'm really trying to making is that regulating the money supply isn't as simple as just not printing money and keeping interest rates consistent, it also requires the management of debt levels and regulations on the practices of fractional reserve banking.

    Nonetheless, it is difficult to argue that the RBA (and other central banks around the world) poorly managed monetary policy if you look at things on a short term perspective and micro level. However it is quite easy to see how this whole global financial crisis was manufactured by creating credit/debt that was overly easy to obtain and that was given without consideration of the already high levels of debt that were present in the economy.

    This is particularly evident by the FED who had the fed funds rate under 2% for three years before quickly jacking up the funds rate five fold over the space of 18 months under the guise of fighting inflation (but it is inflation they largely helped cause through excessive printing). This was all done without consideration of the present debt levels within the economy.

    Also it is important to look at what inflation the central banks like the RBA and FED are claiming to be fighting. They claim to fight commodity based inflation, so prices of oil, food, etc that make up CPI - but they largely ignored inflation in asset prices, being the share market and property prices which was being wholly stimulated by the excessive consumption of debt, ie people were investing based on capital appreciation alone.

    Commodity price inflation does not have a catastrophic baring on the economy long term, conversely it actually helps slow the economy down in times of rapid and exuburent growth, as commodity price inflation places financial constraint on investment projects that are marginal in return. In reality commodity price inflation which leads to CPI inflation and asset price inflation would appear to have been completely brought about the increase in household debt borrowed in Australia and around the world, rather than a shortage in productive capacity. In actual fact it would appear in the light of this downturn that our economies probably had way too much productive capacity being underutilized, but was being invested in based on continued growth.

    You can look at prices of commodities like oil as a reflection of the influence DEBT has had on commodity prices, not what the central banks would love you to believe is natural inflation which was brought on by a strongly growing economy. By this I mean commodity prices boomed over the last few year but have since fallen massively, the common denominator has been the debt levels. Now whilst the world is presently in the process of paying down its exorbitant debt levels coupled with speculation. Now commodity prices have contracted to more realistic levels.

    Anyway the reason I started this thread, was in respect to Australian debt levels. All these contractions to date have been a result of based on the world economy slowing and contracting, but now Australia specifically has just started to reduce its own debt levels, because until now we have been very much lagging the world economy. This debt contraction, will ultimately reduce the money supply and will have dire consequences for the economy, and particularly asset prices whose growth was based on borrowing - ie house prices.

    So I guess what I'm advocating is that someone needs to be regulating the levels of debt within an economy as well. Obviously debt is required my many businesses to function optimally, but excessive debt creation on both the part of business and households should be regulated, as much as, if not more religiously than inflation.

    Actually they are fat cats. My interpretation of the the Reserve Bank Act of 1959, sections 30 and 79, is that all profits go to the Queen (the head of the Commonwealth) and that no taxes are paid on those profits.
     
  7. Chris C

    Chris C Well-Known Member

    Joined:
    2nd Apr, 2008
    Posts:
    1,327
    Location:
    Brisbane, QLD
    I just thought I'd attach a couple of graphs I recently found to explain the exhorbitent level of debt we have been allowed to reach - the come down is going to be very, VERY hard.

    [​IMG]

    And just to give things some perspective, here are the US debt ratios:

    [​IMG]
     
  8. dudek

    dudek Well-Known Member

    Joined:
    10th Sep, 2008
    Posts:
    199
    Location:
    Sydney
    How accurate are these graphs today? I understand much of the debt was written off or many people just simply focused on paying it off as much as possible. Last six months must have reduced overall debt figure significantly.
     
  9. Chris C

    Chris C Well-Known Member

    Joined:
    2nd Apr, 2008
    Posts:
    1,327
    Location:
    Brisbane, QLD
    They are obviously not up to the minute, but things have decreased much in the last 12 months, those articles I listed in my original post highlighted my fear, that credit is starting to contract. If credit had already significnatly contracted our economy would be a lot further in the red.

    Also you can't write off debt, the debt needs to be repayed or the loss needs to be accepted by someone. Also don't expect this credit contraction to happen over the space of months... unforuntaely people still need to pay for living expense so they can't pay down their loans that fast, and given household debt is at around 160% to pay all of that debt back will take 5 years plus. So unless high inflation sets in coupled with very high savings rates I'd expect this deflationary period to last quite a few years.

    Obviously everyone won't have to pay down all of their debt before we see a recovery, but I'd expect that before any meaningful recovery occurs we'll probably need to have the debt to GDP ratio closer to 50 - 75%, which is a more traditional level of debt.
     
  10. dudek

    dudek Well-Known Member

    Joined:
    10th Sep, 2008
    Posts:
    199
    Location:
    Sydney
    That is exactly what I would like to know at this point of time. What is the current debt to GDP ratio? Up to date so many companies collapsed and took all the invested money with them, people who invested lost all. What ever you call it write off or simply rip off someone already paid for much of the bad debt. No one can tell what the debt to GDP ratio today. Things moved so fast in the last 12 months that we may be closer to your 75% that you may think.
     
  11. YChromozome

    YChromozome Member

    Joined:
    9th Feb, 2009
    Posts:
    5
    Location:
    Sydney, NSW
    I don't think you understand the graphs. The bottom one shows household debt as a percentage of household disposable income. This means, if you earn $100,000 a year, the average Australian has $160,000 in debt. (That is average, some own much more, some less or none)

    Therefore to have "reduced this debt significantly", I assume you are suggesting half of it has gone in the last 6 months.

    If everyone in Australia (i.e. households) didn't spend a cent for the 6 months - they don't pay rent, a mortgage, transport costs, buy food etc, but rather put 100% of their wages into debt, then today debt would stand at 110%. This also assumes the banks don't ask for interest on this debt and you didn't pay your income tax.

    So, it's not something that can be paid off "significantly" very quickly.

    Also for every dollar saved, that is a dollar not spent in the economy. That dollar helps pays someone's job, be it the corner retail store, manufacturing, tradie etc.
     
  12. Chris C

    Chris C Well-Known Member

    Joined:
    2nd Apr, 2008
    Posts:
    1,327
    Location:
    Brisbane, QLD
    Did you bother to look at the graphs I psoted above??? Debt to GDP is around 160% and debt to disposable household income is very similar. Both would ideally come back closer to 50% - but that is a LONG way to fall.

    I don't think, I interpret figures. The figures say that our debt is double what has traditionally been acceptable levels.

    Exactly the point I'm making. Thank you for paraphrasing it so succinctly, I was beginning to think many on these forums were unable to interpret the figures logically.
     
  13. dudek

    dudek Well-Known Member

    Joined:
    10th Sep, 2008
    Posts:
    199
    Location:
    Sydney
    I never suggested we reduced it by half. You can manipulate statistics just like you can play with words.

    I just came across of some interesting data. DNB Inside report -Feb 09.

    “The USA Fed has reported that US household dramatically paid down debt levels in November with credit card debt in particular being aggressively cut by US customers”
    Customer credit decreased at an annual rate of 3.75 per cent or $7.9 billion in November. This is the largest percentage decline in eleven years and the largest ever decline in dollar terms”


    I agree you can't please everyone. People aren’t buying cars and houses and don’t use credit cards like they did. They started to save as much as they can or pay off what they can afford. This must have affect on levels of debt. I am not arguing that we are in positive territories but surely we reduced some of the credit in last 6 to 12 months. Therefore I started questiong debt to GDP ratio.
     
  14. dudek

    dudek Well-Known Member

    Joined:
    10th Sep, 2008
    Posts:
    199
    Location:
    Sydney
    I know what I see I am sorry but I just don’t believe this is accurate data.
    I simply don't accept it and it is my point of view nothing to do with reading graphs.
     
  15. YChromozome

    YChromozome Member

    Joined:
    9th Feb, 2009
    Posts:
    5
    Location:
    Sydney, NSW
    The bottom graph is one I generated. As the source says, it came from the Reserve Bank of Australia. The URL for the source is
    http://www.rba.gov.au/Statistics/Bulletin/B21hist.xls

    The latest data available is for the Sep 08 Quarter shows household debt now stands at 156.1% of household disposal income.

    The source of the RBA data is ABS 5232.0 - Australian National Accounts: Financial Accounts, Sep 2008 :
    5232.0 - Australian National Accounts: Financial Accounts, Sep 2008

    Data for the December Qtr is due on the 27 March '09.
     
  16. dudek

    dudek Well-Known Member

    Joined:
    10th Sep, 2008
    Posts:
    199
    Location:
    Sydney
    I look forward to see and compare. I am sure we all are :)
     
  17. YChromozome

    YChromozome Member

    Joined:
    9th Feb, 2009
    Posts:
    5
    Location:
    Sydney, NSW
    Just of a mater of interest, what your guess for the Dec '08 qtr?
     
  18. dudek

    dudek Well-Known Member

    Joined:
    10th Sep, 2008
    Posts:
    199
    Location:
    Sydney
    I strongly believe that we had noticeable contraction in household debt. Looking at spending behavior most of the products traditionally purchased by credit such as cars and houses were down in Q4 08. We shall see.
     
  19. Chris C

    Chris C Well-Known Member

    Joined:
    2nd Apr, 2008
    Posts:
    1,327
    Location:
    Brisbane, QLD
    I'm not quite sure if I'm reading this correctly, but what is the 3.75% a percentage of, total credit card debt?

    Let's assume for arguements sake that it is refering to total credit card debt, if the same rate of credit reduction is assumed to be going on in Australian households (which I'm sure it isn't - at least not yet) then our 165% of debt to household disposable income would have dropped to around 159% over the space of a month, assuming my maths is right. That is still well short of 50% - 75% which would be more ideal. So at this rate it would take a couple of years to get back to reasonable levels.

    What you need to also remember is that this credit contraction is contributing to one of the deepest recessions the US has seen in many decades, and what these figures are suggesting (whether you believe them to be true or not) is that this sort of recession environment prompted by credit contraction has the potential to linger for at least two years.

    At this point I'd like to point out that Australia has yet to see anything on the scale of what the US is going through right now. They lost 600,000 jobs in January alone! They have lost nearly 3 million jobs in the last 6 months! We here in Australia and only just starting to feel it, and when it really hits in the 2Q and 3Q this year it will be like nothing Australia has seen in decades, and seriously has the "potential" to every bit as bad as the Great Depression (though in my optimism I'd like to think that the RBA isn't sadistic and they will attempt to help inflate the economy out of the recession *crosses fingers*).

    In terms of credit contraction, I think it will be less than 1%, but I wouldn't be surprised if there was still credit growth in the 4th quarter of last year. I think first quarter of this year will show some serious contraction if K Rudd gets his stimulus package out in time for people to pay down $950 of their mortgages and credit card balances in the later part of March.

    So you are the author of Who crashed the economy! Welcome to Invested!

    I hope you don't mind me flogging your graph, it just seemed so appropriate for this thread. Keep up the awesome work, I have really enjoyed reading your posts, it's great to know that there are places where people can get the facts and not just the biased media synopsis of the situation that is conveniently positioned next to a relevant half page ad that seem to be the norm in the mass media.
     
  20. YChromozome

    YChromozome Member

    Joined:
    9th Feb, 2009
    Posts:
    5
    Location:
    Sydney, NSW
    No, not at all. The site was started to help get the word out. You are only helping with this.