For nearly two decades both sides of politics have played a game when in government called ‘What Elephant?’.
It works like this: the government sends a frontbench minister into a TV or radio studio, where a journalist will ask ‘what are you doing about this elephant in the room?’
The minister wins points by saying ‘what elephant?’ and answering as if it wasn’t there at all. Terrific fun.
This week, the minister was Mathias Cormann, the journalist was the ABC’s Fran Kelly, and the elephant was a comment from ratings agency Standard & Poors that said Australia had already “hit an extreme measure” of foreign debt and “would have one of the weakest external positions of the 130 sovereign [borrowers] that we rate”.
Mr Cormann’s response was straight from the neo-liberal school of economics, which argues that high levels of private debt aren’t worth worrying about, because every borrower’s ‘liability’ is a lender’s ‘asset’ and the two cancel each other out.
Mr Cormann said S&P’s comments “relate both to government and private sector debt, and of course a lot of the private sector debt goes into investment, capital investment, into our economy, underpinning our economic growth into the future”.
Two types of debt
Mr Cormann’s reply is based on the way a business thinks about debt, but not on the way householders are forced to think about it.
To see why, imagine an unemployable individual who’s inherited a bit of money.
This person can find gainful employment by starting a business, or by buying one.
If he borrows money from a bank, he can leverage up and buy, let’s say, a busy restaurant with a turnover of $1.5 million a year.
From this he can extract a wage for himself of, say, $90,000 annually. On those metrics, he’d pay about $1 million to buy the enterprise.
Each evening, he could drive home to his house, worth $500,000, and relax knowing that he’s got the mortgage, bills, and everything else under control.
The problem is that in Australia today – especially Sydney or Melbourne – he’d more likely be driving home to a $1 million house, meaning that he’ll struggle to service the debt for his business and his home, on the same revenue.
This is similar to the ‘extreme’ situation that S&P is talking about. In Australia, government debt is modest, but per capita private debt is among the highest in the world, much of it borrowed from abroad.
When Australia’s gross external assets – such as foreign shares held by super funds, or Australian-owned businesses abroad – are deducted from gross external liabilities, it turns out that we owe the rest of the world about $A1 trillion.
Now if Mr Cormann’s ‘what elephant?’ comment were true, the lion’s share (no pun intended) would be invested in productive assets – such as factory buildings, plant and equipment, technology or intellectual property.
Some of it is, but way too much is tied up in mortgage debt.
That’s more of a problem than ever, because the flow of capital goods into Australia has slowed dramatically with the tailing off of the mining construction boom – as the chart below shows.
On RBA figures, close to a third of the funding for the $1.5 trillion stock of mortgages in Australia is sourced on global wholesale markets – near enough to $500 billion.
So in net terms, we owe the world $1 trillion, half of which is tied up in non-income-generating houses.
Investor-owned housing stock proves the point – rental yields are at record lows because the capital value of houses has increased much faster than the incomes of the people who live in them.
So while Mr Cormann is right about debt that’s ‘cancelled out’ by the productive assets it’s used to fund, he’s dead wrong about the bloated debt position of the housing market.
To read more columns by Rob Burgess click here.