Foreign Debt is the Biggest Issue | BTalk Australia

(19min 11) On today’s BTalk Australia economist Nicholas Gruen from Lateral Economics gives his view on the economy. His biggest concern is foreign debt and the possibility of capital flight. He suggests why the economic downturn in Australia is different to many other countries overseas and, therefore, requires a different solution.

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• Transcript

Phil Dobbie: Hello, I’m Phil Dobbie and welcome to BTalk Australia. Today, more on the economy, we talk to economist Nicholas Gruen and ask: how do we get out of this?

So what state is the economy really in and is there a way out that isn’t going to be enormously painful? Well, a week or two ago we spoke to Steve Keen [assumed spelling] who said, no, it’s all going to be about debt and it’s going to hurt. So for his view on where next economist Nicholas Gruen from Lateral Economics joins me. Now, Nicholas, as someone who’s not an economist I’m going to ask a lot of naive questions but, perhaps, these are the naive questions that should have been asked a long time ago. But what is the real issue, we’re told that it’s liquidity but it’s also debt so the two are inextricably linked aren’t they? Can we keep our level of debt and still get more cash or do we really have to see our level of debt go down?

Nicholas Gruen: I think we will see our level of debt go down and we’re seeing, for instance, savings rates go right up on the back of people’s fear. But also just people’s habit which is that the banks have typically not lowered their payments they’ve simply lowered the interest payments that are represented in the repayments that they make on their mortgages. And so because they’re continuing to make the same payments they were six months ago but the level of interest is nearly halved they’re saving a lot and they’re therefore retiring debt. So all those things are happening.

Dobbie: But that’s not what the government wanted to happen was it? The government and the reserve bank are saying let’s lower interest rates and let’s give you more cash so that you start spending rather than trying to pay off your home loan faster.

Gruen: Yes, I think that that’s sort of true but I agree with the reserve bank and if we take that as their strategy I agree with the reserve bank and the government in the short term. And, in fact, you may recall a letter that I helped organise with eight economists signing up saying that we actually need policy to push people in the direction of saving less in the short-term but that we very definitely need a plan to get people to save more in the long term. Now that’s hard enough to get over because, you know, any hollow man will tell you that you’ve got to keep your messages simple.

And that’s hard enough. But at the moment what’s going on is that it’s not entirely easy to work out what the government is wanting people to do. And people have a craving in a crisis to pass a bit of suffering around. So it’s all a tricky thing psychologically to say, look spend, although in the short term that’s a sensible thing for us to be trying to do.

Dobbie: That’s right so spend now and save in the long term. We’ve got to completely turn the message around at some point haven’t we?

Gruen: What we’ve got to do is we’ve got to — investment is typically very volatile, business people have more discretion in whether or not to invest than most people feel they have in whether or not to consume. So most people think that most of the things they’re consuming are pretty much, you know, not exactly a necessity but they feel it pretty badly if they substantially reduce their consumption and so they don’t tend to do that. Although they’ll do it at the margin whereas business, if business thinks, oh, crikey I’m not sure the way things are going to look in a year’s time, they can pull right back on investment. So the thing about investment is that it takes investment a long time to kick in. So I think the government is sort of pushing this two-step which is save less in the short term until investment comes on board. And then I would argue that we should be preparing to save more.

Dobbie: Now, the RBA’s been criticized for not cutting rates further.

Gruen: Yes, I’d be happy to join in the criticism.

Dobbie: You think that’s justified do you?

Gruen: Absolutely, if you look at any of the models, any of the economic models and after all they are is just a sort of forcing a method for forcing us to think as logically as possible. The models will tell you that if we think there is a strong case that rates should be lower in the future what the hell are we doing sitting around waiting to lower them in the future we can lower them now.

Dobbie: But if our rates are higher than they are elsewhere is there a case that it could help to draw in some overseas money into the country? Is that what they’re trying to do?

Gruen: No, we don’t have a problem at the moment, that’s another thing we need to keep our eye on, but we don’t have a problem at the moment attracting money. In fact, money is running around trying to find somewhere to invest that’s other than US treasuries which are paradoxically regarded as almost as safe as gold because they’re the international reserve currency even though their economy’s in a bit of a mess and their balance sheet’s looking worse and worse. Australian government backed money is not much better money around in the world so I don’t think that’s much of a problem.

Dobbie: I remember from reading textbooks when I was very young that the value of money has all to do with how much money there is and how fast it’s moving around in the economy. So hearing that the UK is flooding the market with more money I’m thinking how’s that going to work? Surely it’s just going to devalue the value of the pound isn’t it?

Gruen: Do you think they have a problem with inflation in the UK right now?

Dobbie: No, but if the money’s still there when all comes good could that happen?

Gruen: Yes that’s the thing is that it’s a scary business when you start engaging in this stuff because you’ve got more money out there. You can mop it up you can do the way we got the money out there was to have central banks and governments buying assets and so on and you can sell them again, but it’s a scary situation that we’re in and it calls for fairly strong measures. It’s certainly not the case that things couldn’t go wrong as a result of those strong measures.

Dobbie: So is my prognosis right?

Gruen: Think of it as it chemotherapy.

Dobbie: It’s got that bad hasn’t it? So is my prognosis right though that they’re putting more money in because the money’s just not moving around fast enough, so they’re just slinging more money?

Gruen: Yes, they’re scared of deflation and they’re rightly scared of deflation. One of the interesting things is we’ve got a world in which the English speaking countries tend to have central banks and monetary authorities that believe in a sort of basic, well, they believe that the central bank should deliver price stability and within that context try to optimise growth. And the central banks of places like Japan and Europe and the authorities there are much more ambiguous on that point and the result is that they’re sitting around saying, yeah, well, that’s not really our job and, why would you want to stimulate the economy. And they get themself into deflation and they’ll know all about it.

Dobbie: Now, Steve Keen has —

Gruen: And there’s a reasonable chance of that. Sorry, go on.

Dobbie: Steve Keen has said a number of times that debt is the real issue and we’re not going to fix the problem until we fix the issue of debt and debt has got so far out of kilter with the rest of the economy. I guess you partially agree with him but his prognosis on all this is we’ve got to write off that debt we’ve got to have a moratorium on debt. Do you think he’s right?

Gruen: No, it depends. What I would say about debt is that Australia is actually in a rather unfortunate position as concerning debt because we’ve got debt which is foreign debt and foreign debt is of hard constraint. Although it’s kind of — a lot of it’s hedged out of Australia — hedged back into the Australian currency in a kind of fundamental sense in terms of what we have to do to continue to finance it going forward to roll over the loans that we’ve got; this is in the hard currency and it’s somebody else’s currency. Now, that’s a scary thing because there’s nothing we can do about that debt. We can’t forgive it ourselves. We’ve got to meet that debt or default and I think it’s rather early to be talking about default.

Dobbie: Are we more unique — I mean we’re not unique in that situation — but you’re saying we’re worse than for example countries like the UK and European countries.

Gruen: Well, we’re worse than lots of European countries. We’re worse than countries that have tended to run trade surpluses and have an excess of savings. And we’re worse than the United States because although the United States has got itself into this situation where it’s running up foreign debt, the foreign debt is denominated in its own currency. So if the worse comes to the worse they can go for the sort of genteel form of default which is to inflate their currency, and that’s quite possible over the sort of medium to longer term and that’s one of the reasons why it’s surprising that people are being silly enough to keep treating US treasuries as very safe assets, when they’re anything but. But that suggests that the situation that America is in is a qualitatively different to the situation that we’re in. We’ve got a much stronger balance sheet, a stronger economy but our foreign debt is a much harder constraint. So that’s the difference and that’s why I think it’s important for our approach to this whole thing to look rather different to the approach that is being pursued elsewhere because the characteristics of our economy and the particular weaknesses of us are different.

Dobbie: Do you think, also, in this country there’s a relationship between the availability of credit and I know this has certainly been the issue in the US where there’s been too much credit for housing, for example, and that’s effected the price of assets. So do you think there is that relationship between credit and asset prices and —

Gruen: Yes, absolutely. I suppose you can say there’s been too much credit for housing in the US. Yes, that’s a fair comment certainly there was absurd amounts of credit for un-credit-worthy property owners with sub-prime.

Now, has there been too much credit to the Australian property industry? Well, I guess you would say that since our property prices haven’t really gone anywhere for three or four years now, I think since 2004 really, it had too much credit then and we’re going to find out whether it’s got too much credit. The banks are actually pulling back on LVR’s, on loan to valuation ratios, and it’s pretty easy to get a loan; comparatively speaking in Australia you don’t have to have a lot of savings. And the banks are now starting to ration credit by refusing credit to people with less savings. Now, I’m in two minds about that. It’s generally speaking what may be a sensible thing to pull back in that way. If they do that’s likely to pull down house prices. And one of the reasons the banks are doing this is not out of prudential concerns, but more because they’re rationing credit because they got a nice government guarantee sitting in their back pocket and they’re raising capital and they’re off on a shopping spree to pick up some under-priced banking assets in Asia and various other places. Well, I’m not quite sure that’s how we should be using the bank guarantee.

Dobbie: OK, very briefly, just getting back to this enormous switch we have to make from encouraging spending to encouraging the —

Gruen: We should never have been encouraging spending that was a feature of our less than visionary political leaders apart from other things.

Dobbie: So you think the approach of trying to encourage spending in the last couple of government bailouts is —

Gruen: No, no, no, sorry, no, I’m not saying that I’m saying that, basically, the last five years that the Howard government was incredibly feckless. We sat there every time the government looked in the kitty it found another $5 billion from the resources boom and then it said, oh, well, what do we do with this and then sort of handed it out in cheques of multiples of $100 to whoever it could think of. Now you might excuse that when the $5 billion turning up was a surprise to the government, which I guess it was first off, but this happened every six months.

And you would have thought that within a year or so that they would have actually had policy processes in place to work on constructive things to do with all that money. But it was obvious that they, basically, kind of came up to a budget and looked at the bottom line and then thought OK how much money can we dole out?

Dobbie: So you’re behind the government in terms of its approach now in terms of encouraging spending. When we get to the point when we have to say, well, OK we’ve boosted enough spending within the economy now we’ve got to try and turn the ship around.

Gruen: What’s relevant is we boost spending and we’re trying to boost investment and it’s when we’ve got investments taking up the slack where we then try to save to fund the investment and that’s a tricky process. And that’s the part where our instinct to try and sort of share sacrifice in the community so we can build a stronger community and economy, that’s where those things make sense. And we don’t really hear a lot of that from the government. The last time I heard that sort of rhetoric was really Bob Hawk in 1983, but that’s the way we would have to think and we should be sort of thinking now and preparing to think now and actually implement in a year or so.

Dobbie: This isn’t really the game you’re into but if you were to make predictions as to what we’re likely to see out for the rest of this year. I mean everyone’s asking that question. Where do you think we are headed and, for example, is unemployment going to get to seven or eight percent and is the government going to have to pump more money into trying to increase spending and also increase investment?

Gruen: Look, as you know, my immediate response to those sort of questions is don’t get an economist get a clairvoyant. But what’s my guess, which is where are we going to be? I think unemployment’s going to keep going up. And I think if the world economy gets halfway stabilised then you can mount an argument that that’s roughly where it is — like it’s almost there now that the banking system has been stabilised to a substantial extent, there’s all sorts of things that have to be fixed out in America and Europe fast. The performance of the Obama administration in that particular regard in terms of stabilising the banking situation’s been pretty awful. But if that stabilises, I think our economy could do OK in the short term. I think our housing market could stabilise and start going up with these kinds of interest rates. And our current account deficit will blow out like nothing else and that’s why I think that’s where our policy attention should be.

The alternative scenario is that the world goes into a Japan style lost decade, that it’s very, very flat and that we have horrendous recessions around the world and then our foreign debt becomes a problem and our capacity to live our lives as comfortably as we our now will simply drive our current account deficit up hugely, and something may will give at that stage. In that sort of scenario I think that’s a very different scenario in which, for instance, we’re not able to sustain such low interest rates for our economy because it produces capital flight. And that’s a horrible situation to be in. At the moment we’re regarding that as just sort of an outlandish possibility and I don’t think it’s outlandish, well, it probably won’t happen but it’s not something we should rule out. This is hardly a time you’d have great confidence in saying, well, we won’t have any nasty financial crisis.

Dobbie: And you think I’d get all of that from a clairvoyant do you? For now thank you very much for your time today.

Gruen: See you later, bye.