Is Australia Risking a Debt Crisis?

In America’s real debt crisis (15 May), I wrote: “The choice is stark: Americans must either undertake radical budget reform and (public) debt deleveraging, or accept continued economic stagnation – and if current trends worsen, eventually risk a debt crisis. They categorically refuse the former, so they blithely accept the latter.”

What about Australia? In this article, I analyse public (the sum of federal, state and local government) as well as private (corporate and household) debt in Australia, Britain and the U.S. since the 19^th century. I uncover commonalities among and differences between these three countries:

1. In each, the ratio of total debt to GDP has risen greatly since the 1980s – most rapidly by far in Australia, albeit from a low base, since the GFC. Indeed, this country’s recent plunge from low to high public debt is unprecedented.
2. Household debt is the biggest component of total debt here; conversely, public debt is the main contributor to America’s and Britain’s rising total debt.
3. American and British households’ ratios of debt to GDP have decreased significantly since the GFC; in Australia, in contrast, this trend is at best embryonic.
4. In this country as in the U.S., rising debt is stifling economic growth: each additional $1 of debt is generating ever less than $1 of extra GDP. But unlike the U.S., where it’s growing exponentially, debt here is growing less rapidly (linearly).

My conclusion contains good news: a domestic debt crisis seems less likely to erupt in Australia than in America or Britain (where it’s also improbable). But there’s also bad news. It’s reasonable to expect that this country’s debt-induced stagnation won’t merely persist: it’ll intensify. Here, as in Britain and the U.S., fiscal recklessness is rife and reform is too hard; hence there’s plenty of scope for the situation to worsen.

Australia’s addiction to high and rising government spending, budget deficits and debt will continue to place upward pressure upon consumer price inflation and rates of interest; it’ll also stifle economic growth. That, in turn, augurs poorly for living standards – and most assets’ returns.

Public Debt

Using data from the Global Debt Database compiled by the International Monetary Fund (which is also the source of the data in Figures 2-10), Figure 1 plots Australia’s gross public debt (the sum of the colonies’ debt until 1900, and of state, local council and Commonwealth debt since 1901) as a percentage of Gross Domestic Product (GDP). Broadly speaking, the ratio’s evolution shows three phases.

Figure 1: Gross Public Debt, Percentage of GDP, Australia, 1860-2022

During the first, it rose cumulatively massively – from 9% of GDP in 1860 to 92% in 1946. But it didn’t rise continuously: perhaps as a long-term consequence of the banking crisis and depression of the early 1890s, it sagged from 60% in 1895 to 26% in 1911; as a result of heavy borrowing during the First World War and throughout the 1920s, it zoomed to 98% in 1932; during the Great Depression it waned (to as low as 69% in 1937) and during the Second World War it waxed (to 92% in 1946).

In the second phase, from the end of the Second World War until the outbreak of the GFC, the ratio fell almost without interruption to 10% ‒ which was the lowest percentage since 1863.

During all but a few of these years (1996-2007) neither nominal nor CPI-adjusted public debt decreased; instead, it rose much less rapidly than GDP; as a result, the ratio of public debt to GDP fell cumulatively and massively.

Since the GFC, however (which forms the start of what I’m assuming is the third major phase), public debt has climbed rapidly whereas GDP has increased sluggishly. The ratio has thus rebounded; indeed, it’s increased without interruption to 58% in 2022.

That’s the biggest since 1949. It’s also the ratio’s largest and fastest rise on record: in no other 15-year period, in other words, has it increased by more than the 49 percentage points it did from 2007 to 2022.

Table 1 substantiates this crucial fact. I ranked-ordered the series in Figure 1, divided the sorted series into five equal groups (by the number of observations) and computed each group’s average ratio of public debt to GDP. During one-fifth of the years since 1860 (Quintile #1, which I label “low debt”), the ratio of debt to GDP has varied between 8.5% and 20.5%. Conversely, one fifth of the time since 1860 (Quintile #5, “high debt”), the ratio has exceeded 59.7%.

Table 1: Australia’s Ratio of Public Debt to GDP, by Quintile, 1860-2022

Since the eve of the GFC, Australia’s ratio of public debt to GDP has vaulted from among the lowest in its history to the boundary between Quintiles #4 and #5. In other words, it’s skyrocketed from among the lowest 2-3% of observations since 1860 to among the highest 22% ‒ and, it’s reasonable to suppose, during the next few years will climb into the “high debt” Quintile #5.

Does Australia’s presently high and rising public debt imply a crisis at some point? At present, that’s probably drawing a long bow. When adjusted for the consumer price index (using data compiled by the RBA), Australia’s public debt (as opposed to its ratio of public debt to GDP) has usually been far higher in the past than it is now (Figure 2).

Figure 2: Gross Public Debt, Australia, Trillions of CPI-Adjusted $A, 1922-2022

Total Commonwealth, state and local government debt is presently $1.35 trillion. It’s true that it’s risen from just $0.22 billion in 2007, and that CPI-adjusted public debt is now higher than at any time since 1973. Equally, however, it’s been far higher during much of the past century: it averaged $2.38 trillion during the 1960s, $1.88 trillion during the 1950s, $4.87 trillion during the 1940s, $4.49 trillion during the 1930s and $2.78 trillion during the 1920s.

Since 1989, the IMF’s Global Debt Database has disaggregated Australia’s public debt into its two (Commonwealth and state/local government) components. Until the mid-1990s, as a result of rising debt as well as stagnant and falling GDP, both levels’ ratios rose (Figure 3).

Figure 3: Categories of Public Debt as Percentages of GDP, Australia, 1989-2022

During the next dozen years, however, both ratios of debt to GDP fell to levels below those prevailing in the late-1980s. And since 2005, both have risen. Canberra’s has skyrocketed eight-fold from 6% in 2007 to 44% in 2022, whereas state and local governments’ ratio has risen just half as quickly, i.e., four-fold from 3.6% to 14.4%. Of course, states’ finances vary greatly: WA’s are comparatively good, NSW’s mediocre and Victoria’s, relatively speaking, awful.

Nonetheless, state and local governments’ ratio of debt to GDP was little higher in 2022 than in the early-1990s; similarly, the ratio of state/local to total public debt (ca. 30%) has remained remarkably stable. The Commonwealth’s ratio, in contrast, was three times higher last year than it was 30 years ago – and there’s no credible sign that its current rise will soon abate.

Anglo-American Comparisons

Why do Australian governments’ rising debts seem to trouble neither Australians as a whole nor their rulers or foreign creditors? It’s not just that CPI-adjusted debt was far higher in the distant past; perhaps it’s also because other countries’ ratios of public debt to GDP are presently twice as high – or more – than Australia’s; thirdly, in these other countries it’s been far higher in the past than in Australia today.

Figure 4 compares Australia’s public debt as a percentage of GDP since 1860 to Britain’s and the U.S.’s since 1800. Since 1860, Australia’s ratio has averaged 39%; during the same interval, Britain’s and the U.S.’s have averaged 89% and 44% respectively; and since 1800, Britain’s has averaged 112% and the U.S.’s 33%. Over the super-long term, Australia’s average ratio is much lower than Britain’s and a little higher than America’s.

Figure 4: Gross Public Debt, Percentages of GDP, Three Countries since 1800

Broadly speaking, Britain’s ratio shows five phases:

1. In order to fight the Peninsular and Napoleonic wars from 1800 to 1815, the ratio zoomed from 176% in 1800 (the already very high level incurred to combat Revolutionary France) to as high as 261% in 1821.
2. It then commenced a very long and cumulatively drastic decrease – to 27% in 1914. Britain achieved this result by (a) freeing its economy from myriad agricultural and trade restrictions, which over time greatly increased its GDP, and (b) running budget surpluses and using the surpluses to repay debt.
3. The First and Second World Wars caused the ratio of debt to GDP to skyrocket. It jumped as high as 219% in 1923, and then halved to 123% in 1940 before doubling (and then some) to its all-time high (270%) in 1946.
4. From then until 1991, the ratio gradually collapsed to 28%. This time, however, consumer price inflation did most of the work: in nominal terms, debt rose rather than fell; but thanks to the growth of CPI, GDP rose much faster than debt; as a result, their ratio fell.
5. Since the early-1990s and especially since the GFC and the COVID-19 panic, the trend has been sharply upward: to 43% in 2007, 85% in 2019 and 104% today. As a result, Britain’s ratio is higher today than at any time since 1963.

In the U.S., war has usually but not always caused the ratio of public debt to GDP to spiral. Moreover, war’s effect upon debt has been less drastic there than in Britain. During the first quarter of the 19^th century, for example, including the War of 1812, the ratio varied from 8% to 18%. It then began to fall, and by 1833 it reached 0% – the first and only time in U.S. history that it has fully repaid its national debt. Until the outbreak of the Civil War in 1861, public debt remained within the range 1%-4% of GDP.

The Civil War caused the ratio to rocket to 30%. It then receded, to 3% in 1893, and generally remained within the range 3%-5% until the country entered the First World War in 1917. The ratio zoomed to 33% in 1919 but plunged to 18% by 1929. During the Great Depression it more than doubled (to 44% in 1939), and then trebled during the Second World War (to 121% in 1946).

As in Britain, so too the U.S.: after the war GDP increased much more quickly than public debt; consequently, the ratio fell cumulatively drastically (to 53% in 2001). Then came the attacks on 9 September 2001 and the “War on Terror” – and the ratio rose to 66% in 2005; then came the GFC, and the ratio rose to 100% in 2011. The torrent of deficit spending continued after the GFC, and the ratio rose to 109% in 2019. Then came the COVID-19 panic and the torrent accelerated (to 135% in 2020) before receding somewhat (to 128% in 2022). As a result, and led by its federal government, America’s ratio of public debt to is now the highest in its history. Financially, it’s as if the U.S. Government is refighting a never-ending conflict even bigger than the Second World War.

An apologist of Australia’s ratio of public debt to GDP would stress that adjusted for CPI it’s smaller today than it was in the 1920s-1960s. It’s also much lower than current and many past levels in Britain and the U.S.

Levels versus Rates of Change

That defence isn’t false, but it’s incomplete and thus potentially misleading. It’s true that, regardless of the interval of time, the level of Australia’s ratio of public debt to GDP has mostly been significantly lower than in the other three countries (Figure 5).

Figure 5: Mean Levels of Gross Public Debt, Percentages of GDP

Yet the ratio’s rate of increase since 1980, 1990 and 2007 mostly exceeds – and since the GFC greatly exceeds – the other countries’ (Figure 6). Until the GFC, Australia’s public debt was low by its own historical standards and by prevailing American and British standards; today, however, thanks to its rapid rate of increase, that’s no longer so.

Figure 6: Increases (Percentage Changes) over Three Intervals of the Ratio of Gross Public Debt to GDP

Private Debt

Figure 7 plots non-financial corporate debt as percentages of GDP in these three countries (the IMF’s GDD data for the U.S. have been available since 1950, for Britain since 1966 and for Australia since 1977). The trend of each series is upwards (but weakly so since the GFC): Australia’s ratio has averaged 64%; since 1977, Britain’s has averaged 63% and the U.S.’s 61%. Today, Australia’s ratio is 65%, Britain’s is 72% and the U.S.’s is 81%. Australia’s ratio is now somewhat lower than the others’, but historically there’s been little difference.

Figure 7: Non-Financial Corporate Debt, Percentages of GDP, Three Countries

Since the turn of the century, however, Australia’s ratio of household debt (which overwhelmingly comprises residential mortgage debt) to GDP has significantly and increasingly exceeded the American and British ratios (Figure 8). Today’s ratio is 119%, whereas Britain’s is 86% and America’s is 78%.

Figure 8: Household Debt, Percentages of GDP, Three Countries

Moreover, the American and British household sectors have deleveraged since the GFC: since 2009, Britain’s ratio has fallen 11% (from 97% to 86%) and America’s has sagged 20% (from 97% to 78%). However, during that interval Australia’s has risen 6% (from 112% to 119%).

On the other hand, since 2015 Australia’s ratio of household debt to GDP has been stable (average of 122%). Perhaps a slight tendency to deleverage has commenced?

Total Debt: Public and Private

Figure 9 plots the three components of Australia’s ratio of total debt to GDP. The trend is relentlessly upwards; since the late-1970s, the ratio has risen 2.5-fold, from 93% in 1977 to 243% in 2021. Corporate debt’s ratio has trended upward, but comparatively weakly, and thus hasn’t contributed greatly to the total ratio’s sharp rise.

Figure 9: Components of Total Debt, Percentages of GDP, Australia

From the late-1970s until the early 2000s, and as we’ve already seen, the ratio of public debt to GDP fell; accordingly, it restrained rather than abetted the rising ratio of total debt to GDP. During these years, rising household debt was the major contributor to overall rising indebtedness.

Over the past 20 or so years, in contrast, both the household and public debt ratios have risen. And since 2015 the household ratio has stabilised and so the total ratio’s continued rise during and since the COVID-19 panic has been mostly attributable to rising public debt.

Figure 10 plots the consequences. As in Australia, so too in Britain and the U.S.: since the early-1980s the ratio of total debt to GDP has risen almost without interruption. In the 1980s, the Australian and British ratios were significantly smaller than their American counterpart; today, they remain lower but the margin is smaller.

Figure 10: Total Debt, Percentages of GDP, Three Countries

Using quarterly data compiled by the ABS, Figure 11 and Figure 12 plot Australia’s CPI-adjusted GDP and total debt. Over the past 30 or so years, GDP has risen from approximately $1 trillion to ca. $2.5 trillion, and total debt from less than $1 trillion to more than $4 trillion. On a per capita basis, total debt has grown from $37,000 to $166,000, whereas GDP has grown less rapidly, from $54,000 to $95,000.

Figure 11: Australia’s GDP and Total Debt, Quarterly, CPI-Adjusted Trillions of $A, 1993-2022

Result #1: in one fundamental respect (as detailed America’s Real Debt Crisis, 15 May), Australia’s debt problem isn’t as severe as America’s: both total CPI-adjusted total debt and per capita CPI-adjusted total debt are growing linearly rather than exponentially.

Figure 12: Australia’s GDP and Total Debt, per Capita, Quarterly and CPI-Adjusted Thousands of $A, 1993-2022

Result #2: Australia and the U.S. also share a critical characteristic: total debt is growing more rapidly than GDP; hence their high and rising debt is stifling economic growth.

Whether it’s gross or per capita, whether the change is a mean over rolling 12 month periods or a five-year average of rolling 12-month changes (which removes short-term random components of fluctuations), and whether GDP includes or excludes net exports, the result is the same: over the past 30 years its trend has been downward.

Figure 13 plots the five-year means of 12-month rolling percentages of (1) per capita GDP and (2) per capita GDP less net exports. From September 1992 to September 1993, for example, CPI-adjusted per capita GDP rose 2.1%. From October 1992 to October 1993, it increased 2.7%, ..., and from September 1997 to September 1998 it rose 4.7%. The five-year mean of these 12-month rolling means is 2.3%, and so on to 2022.

GDP comprises consumer spending (C), government expenditure (G), investment (I) and net exports (X). For my purposes, it’s revealing to exclude net exports and thereby plot an alternative measure of per capita GDP.

For most of the time since 1993, Australia’s imports have exceeded its exports; as a result, net exports have been negative. During the past five or so years, however, net exports have risen to a 50-year high.

Unlike consumer and government expenditure, which directly affects almost all Australians, net exports effect affect most people indirectly, i.e., via the taxes and royalties that governments receive and then recycle into expenditure. Net exports directly and disproportionately affect comparatively small numbers of people, e.g., exporters’ employees and owners.

Accordingly, at times like the present when net exports have scaled an historic high, CPI-adjusted, per capita GDP excluding net exports – and its percentage change over time – provides better measure of individual Australians’ welfare.

Figure 13 corroborates this expectation. From 1997 to 2016, the two measures of CPI-adjusted per capita GDP tracked one another very closely. That’s because the “X” component of GDP was mostly negative but usually relatively small. Before the GFC, both measures of per capita GDP growth averaged ca. 2.5% per year. And from 2009 to 2016-2017, both plummeted such that by 2016-2017 their rates of growth became negative.

Figure 13: Per Capita GDP, Two Definitions, Five-Year Average of 12-Month Percentage Changes, 1997-2022

Since then, per capita GDP has rebounded to a growth rate of approximately 2% per year in 2022; the measure excluding net exports, however, has recovered much more sluggishly – to growth of less than 1% per year in 2022. From 1993 to 2008, the growth of per capita GDP excluding net exports averaged 2.7% per year; since then, it’s averaged just 0.53% per year; as a result, throughout this interval its trend has been strongly negative.

Figure 14, which plots 12-month percentage changes, tells much the same story. It also corrects the myth that before the COVID-19 panic Australia enjoyed almost 30 years of uninterrupted economic growth. On a “headline” GDP basis, that’s not false; but per capita, no fewer than four recessions – including an extended one from 2013 to 2016 – occurred during these years.

Figure 14: Per Capita GDP, Two Definitions, 12-Month Percentage Changes, 1993-2022

Result #3: As in the U.S., so too in Australia: since the 1990s, each additional $1 of per capita total debt has generated considerably less than $1 of per capita GDP (Figure 15). Using the standard measure of GDP, the trend is perfectly flat: on average since 1997, an additional $1 of total per capita debt has generated an average of just $0.40 additional per capita GDP.

It’s true that since 2016 this relationship has seemingly rebounded strongly – that is, an extra $1 of total debt is now associated with a much greater ($0.80) increase of per capita GDP. But as the second (red) series shows, that’s because net exports have risen greatly.

Using the alternate measure (ex net exports), the relationship is strongly negative. In the late-1990s, an additional $1 per capita debt has generated an additional $0.70 of per capita GDP. Over time its impact has waned: by 2017-2018, it generated a decrease of per capita GDP; today, it’s just $0.20.

In other words, the recent sharp recovery of per capita GDP’s growth is mostly the consequence of the export boom – and not of the sharp rise of government spending and debt. Over the past 30 years, the growth of per capita GDP has stultified not despite the rising total debt, but because of it.

Figure 15: Effect upon per Capita GDP per Increase of $1 of Total Debt, Five-Year Average, 1997-2022

Conclusion and Implications

A country’s high debt load is a bit like a fat man’s Body Mass Index. Just as an obese-range BMI is a typical consequence of poor diet and exercise over the years, high debt usually results from an extended period of lax policy. Moreover, high debt and excess weight can cause new or aggravate pre-existing problems: in particular, although for a time it can obscure it, debt can cause and eventually exacerbates sluggish productivity.

Like good health, so too sound finances: they’re much easier to maintain than restore. That’s why – until a crisis forces their hand – highly-indebted countries typically follow the path of least resistance: they borrow rather than undertake the reforms required to return their finances to health. These countries resemble the fat man who can either (1) diet, exercise and lose the excess kilos or (2) borrow and buy bigger clothing. On scores of occasions over the past half-century, America’s best and brightest have chosen to raise its ceiling rather than restrain its debt.

The good news is that a debt crisis seems much less likely to erupt here than in America or Britain (where it’s also presently improbable). But there’s also bad news: it’s reasonable to expect that these countries’ debt-induced stagnation won’t merely persist; it’ll intensify.

Although the mainstream denies or resists the diagnosis, this disease has long afflicted Australia. Measured by per capita GDP excluding net exports, over the past decade this country has spent more time in a recession than not (see also America’s permanent recession: Is it coming to Australia? 19 April 2022). In response, governments have accumulated ever more debt, but its returns are becoming ever more meagre.

This article’s results provide another reason to anticipate high (by mainstream standards) consumer price inflation and rates of interest. In Why inflation is and will remain high (15 August 2022), I demonstrated that profligate monetary policy and fiscal policies are the ultimate cause of consumer price inflation. Indeed, “central banks’ monetary policies and treasuries’ fiscal policies are presently more inflationary than at virtually any other time during the past century. It’s thus no surprise that consumer prices in Australia, Britain, the U.S. have recently risen at rates not seen in decades.”

I see no reason to believe that central banks and governments will reverse (or even abate) their highly inflationary policies. Hence there are no grounds to expect that CPI’s growth will quickly subside to the RBA’s 2-3% target (see also Farewell low “inflation” and interest rates? (20 February 2023).

Consumer price inflation that remains higher for longer also means unexpectedly high central bank policy rates (see also The Risk of Higher Rates the RBA’s Overlooking (20 March 2023, particularly Figure 3). And for reasons detailed in this article and in America’s Real Debt Crisis (15 May), it’s reasonable to expect – whether or not a recession occurs within the next year – that GDP’s rate of growth will continue to stagnate.

What are the consequences of higher CPI and rates of interest and of lower GDP growth for investors’ returns? In Three risks you can discount – and one you can’t (3 December 2021) I analysed American data since the 1870s and demonstrated that during times when GDP growth is comparatively sluggish and CPI and rates of interest are relatively high – such as the present – investors typically suffer significant losses.

It’s true that a recession would likely crush CPI and rates of interest. Equally, it would also shrink GDP and likely smash investors’ nest-eggs (see Recessions usually crush shares – but investors can always reduce their ravages, 31 October 2022) and How we’ve prepared for the next bust, 28 November 2022)

In Will 2023 be beautiful or ugly? (23 January 2023) I concluded: “on balance, and taking the possibility of recession into consideration, 2023 is more likely to be ugly than beautiful. What’s certain is that at some point something will surprise everybody.” Approaching this year’s mid-point, that conclusion remains reasonable.

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