There is no GFC…

One of the unexpected things I’ve learnt in Boston is that the Global Financial Crisis is not called the Global Financial Crisis in America–and therefore the TLA of the GFC has no meaning here.

Instead, in America this might be The Crisis That Has No Name (TCTHNN), because they don’t call it anything at all: it’s just how the economy is right now.

Australians, it seems, are the ones who invented the moniker GFC as a way of describing what they think they don’t have to understand. Over here, where it is actually happening, it is just the day to day reality that must be contended with.

Even more peculiar is news from some finance sector insiders here who have been in touch with Australia’s RBA and Treasury, that they describe it as not the GFC, but the “North Atlantic Financial Crisis” (“NAFC”)–arguing once again by a label that this crisis is peculiar to the US and Europe.

Apparently when asked what Australia has learnt from the crisis, the answer was often “Nothing, because it didn’t happen here”. The Lucky Country, it seems, is seen as immune to the crisis by its economic managers.

I know that I’m more likely to be spoken to by Bears in Boston than Bulls, but even the Bulls find this Australian complacency–even smugness–about the crisis bemusing. One insider I spoke to–admittedly a Bear–commented that he found it so annoying on his last visit to Australia that he’s sworn never to return.

Good riddance might be the attitude of some; who needs the negativity? Well, we might, if the causes of the crisis are not in fact peculiar to the North Atlantic.

For though the GFC might have had very little bite in Australia to date (and I admit that the mildness of the downturn to date in Australia did surprise me) we can only kiss it goodbye if it was really just a Northern Hemisphere Black Swan. If instead its causes are more general, then as the US now starts to fear a DDR (Double Dip Recession), Australia might find that it’s not so Lucky after all.

Here there is one indicator that I think explains why Australia has not suffered as badly as its North Atlantic counterparts, but also why there will be no easy recovery: the contribution that rising debt makes to aggregate demand. Though I am a critic of the extent to which our economies have become debt-dependent, there’s one unmistakeable fact about our post-1970 recoveries: they have all involved a rising level of private debt compared to GDP.

I’ve recently done a comparison of how the US today compares to the US in the 1930s on this front, and the results–published in an earlier post–were intriguing.

The US was actually suffering a more severe private sector deleveraging this time than in the 1930s: in 1928, rising debt was adding about 8% to the level of aggregate demand. That is, demand was 8% higher than it would have been had debt been constant. By the depths of the Great Depression, falling debt was making aggregate demand about 25% lower than it would have been had debt been constant.

The story for today is more extreme: at the end of 2007, rising debt made aggregate demand 22% higher than it would have been had debt been constant–so rising debt today was almost three times as important in our pre-GFC boom as it was in the 1920s. Two and a half years later, falling private sector debt was reducing demand by almost 15%. This was not as bad as the worst levels of the Great Depression, but worse than in 1931, which was the comparable time from the beginning of the downturn in private debt.

The positive difference between then and now in the USA turned out to be the contribution to demand made by rising Government debt. The government-financed proportion of demand in the Great Depression was trivial two years into the crisis, and only became substantial–at about 7.5% of aggregate demand–three years in. In contrast, government spending is making aggregate demand almost 13 percent higher now. But even then, the USA is still deleveraging.

That’s the comparison the the USA today with itself 80 years ago; what about the comparison of the USA today with Australia today? The chart below provides it.

Firstly, Australia is running a couple of months behind the USA in the crisis. But that’s minor compared to the difference in scale. Private debt added slightly less to demand in Australia during the boom times–a maximum of 18.75% of aggregate demand was financed by private debt, compared to over 22% for the USA. But deleveraging hasn’t even begun here: the private-debt-financed contribution to demand flirted with zero in late 2009, but has been positive throughout. Rising private sector debt today is adding about 2% to aggregate demand. Rising government debt is adding about another 2 percent on top of that.

So Australia hasn’t yet delevered–in contrast to the USA. Does that mean we have a “get out of the GFC Free” card? That depends on whether we’ve avoided what caused the GFC in the first place–a runup of excessive private debt during a speculative bubble.

There the answer is equivocal. While we have substantially less debt than the USA (though some correspondents have argued that the RBA figures I use understate the level of finance sector debt here), our debt to GDP ratio is 90% higher than it was back in the Great Depression.

So we have less deleveraging potential than the USA, and we haven’t even begun to do it yet–which is why the GFC has appeared to be a North Atlantic phenomenon. And if we can prevent deleveraging, then we won’t see the depths of the downturn that the North Atlantic has seen either.

But there is a downside to no deleveraging. We have a household sector that is even more indebted than its US counterpart. The odds are that this sector will be debt-constrained in its spending, and the recovery will be stalled as a result. So the GFC is not entirely a NAFC.