The 7.30 Report Steven Keen talks to 7.30 Report
Broadcast: 08/10/2008 Reporter: Kerry O'Brien
Associate Professor Steven Keen has come increasingly to prominence over the past couple of years specialising in the economics of Australia's spiralling household debt burden. He spoke to 7.30 Report tonight.
KERRY O'BRIEN, PRESENTER: We've now seen how the one percentage point interest rate cut has impacted on the Australian stock market today; a 5 per cent drop in the value of Australian shares.
Another big question now is how is the cut going to impact on the housing market, which has long been at the heart of Australia's social and economic culture?
For decades Australia had been... or had one of the highest home ownership rates in the world.
In fact for many until the recent explosion in superfunds, it's been the only way they have been able to accumulate any personal wealth at all.
Associate Professor Steven Keen has come to prominence specialising in the economics of Australia's household debt burden.
Initially he was almost a lone voice with his pessimistic view of how dramatically that burden could impact on us all. He's not alone now.
And believes Australia faces a savage correction including an inevitable housing slump.
I spoke with Professor Keen earlier tonight.
Steve Keen, I would think that when the Reserve Bank announced its interest rate cut yesterday the first reaction if most Australians, the first reaction, would have been to work out what the saving was on their mortgage repayments.
The next question for many homeowners would be will the value of their home start to go up again?
What is going to happen to the housing market now particularly with the assumption we will see more interest rate cuts?
PROFESSOR STEVEN KEEN: Well I think for a while there will be people that do the calculations and think happy days are here again onto the next housing bubble.
But the reality is housing prices in Australia run at seven times the median incomes, when the affordable level which the demographic survey works out rather well, is about three times.
And to put that in context the American market, after all the crashing it's been through is down to three and a half times median income level.
So we're talking about a house price level in Australia which is twice the level that America got to. And that means, I think unfortunately, the only direction in the long-term for house prices is down.
KERRY O'BRIEN: And yet the local wisdom that has emerged from America's credit crunch, its sub-prime crisis is that our problems, whatever they are, are nothing like theirs.
That the sub-prime crisis has been a very dramatic collapse in the housing market
PROFESSOR STEVEN KEEN: Incredibly dramatic. And the reason was, the sub-prime was about lending to money to people who had a record of not repaying it and claiming it could make money out of doing it.
Which was a classic American scam and its now falling apart, of course it's not just in the hands of the poor Americans, but in the hands of the scam merchants as well.
So, that's something that is peculiarly American. But at the same time here our debt levels here are in fact slightly higher than those in America.
KERRY O'BRIEN: So in other words you are saying that there is a significant way for Australia's housing market to drop?
PROFESSOR STEVEN KEEN: It has to be; it's simply unaffordable at the level it is now. The only way you can get your house to be sold for a higher price than you bought it for is that if somebody takes out more debt than you did relative the their incomes.
And that's got to the point where it's simply unsustainable. The proportion of Australians that can afford the pay for the median home has dropped well below the actual median of the population.
KERRY O'BRIEN: Are we going to see home building start up again, or is that going to continue to slump? Are we likely to see those spiralling rents stabilise, or is that going to keep going up?
PROFESSOR STEVEN KEEN: Well I think Kerry I can actually make a reference to what's happened to the Australian dollar say every price you see is crazy.
There is no way the prices of anything make any sense at the moment. However, I think ultimately the most senseless prices are our house prices; they have to fall.
In that environment nobody is going into trying to build properties when there's the expectation ever losing rather than capital gain.
This has happened in New Zealand, it's happened in England, happening in America. The ratio of house builds to population has dropped dramatically once this crisis has hit; even when they've been housing shortages.
KERRY O'BRIEN: In your latest Debt Watch blog you compare private debt ratios with the US and Australia with the same debt ratios at the time of the great depression. How valid is that comparison? How do they compare, and what do you draw from it?
PROFESSOR STEVEN KEEN: Well if you look back to 1929 when the stock market bubble burst in America the ratio of debt to GDP was 150 per cent.
It rose to 215 per cent as the economy collapsed, not because debt was rising any more but because prices were falling and output was also falling.
It is now 290 per cent. That is gigantic, virtually twice the level. Australia had a lower level of debt back at the start of the Great Depression; our debt ratio was 64 per cent.
It is now 165 per cent. So we have that much more debt than we had, and really the only sensible explanation of what caused the Great Depression is a combination of excessive debt and falling prices.
Now we have one of those two in spades now, twice as bad as during the Great Depression on the OECD scale. So for that reason I think the comparison is extremely valid and the prognosis is extremely bleak.
KERRY O'BRIEN: So within the landscape of the global economy, which again we're not sure... nobody really seems to be able to say with confidence where it is going. What do you think is likely... most likely to happen to the Australian economy now over the short to medium term?
PROFESSOR STEVEN KEEN: I can see us going into a serious increase in unemployment, a serious economic slowdown.
Credit level's collapsing; we've already seen that starting to happen in the most recent figures.
And a credit driven downturn in the economy, driven largely through a collapse in retail sales, because this time around the part of society carrying the debt is the household sector; it business sector in the 1920s and also of course in the 1990s.
Households can't sack the kids; they can't declare themselves bankrupt anywhere near as easily as a corporation can do. So the only thing they can do to control their situation is to cut back drastically on retail spending; and that will of course mean the retail sector is the first one to collapse.
KERRY O'BRIEN: Well the household squeeze in the past year has been driven by rising interest rates and rising petrol prices; both those are now coming down quite dramatically.
Won't that combine with the big tax cut now flowing through into household pockets to free up consumer spending again against what you are suggesting?
PROFESSOR STEVEN KEEN: It certainly will help. And we're lucky in one sense that we have, first of all, a higher reserve rate than America so we've further to drop that reserve rate.
And our mortgages are closer to the reserve rate. In America there's absolutely no relationship between then the reserve rate and mortgage rates.
Reserve rates there have fallen from 6 per cent to 2 per cent and mortgage rates have actually gone up across that period. So America's got a much worse situation than we have.
But even if you do have a dramatic drop in the interest rates that's nothing in terms of its impact on spending compared to what's happening to people deciding they will no longer borrow.
This is where you need a monetary perspective on the economy. Our total spending is the sum of GDP plus the change in debt. Last year our GDP was roughly a trillion dollars, and the increase in debt was roughly a quarter of trillion dollars.
Now if we suddenly had people deciding not to borrow anymore, that means 250 billion of spending power, even though it's borrowed money, disappears from the economy.
If you're trying to top them up on the other side by reducing the interest payment burden, even knocking off 1 per cent off the rates reduces the debt repayment burden by $18 billion, because that now is roughly $1.9 trillion in this economy.
$18 billion, if an increase in spending power, versus $250 billion of a fall in spending power; I'm sorry, the nays have it.
KERRY O'BRIEN: In your scenario it would seem likely interest rates will fall significantly beyond what they have already done?
PROFESSOR STEVEN KEEN: I was saying even when the first rates were being talked about the last quarter of a per cent cut that I expected the reserve be down 2 per cent at the end of 2009 and probably zero by 2010.
KERRY O'BRIEN: The share market... we saw Australia's share market tumble 5 per cent again today. Over the course of this calendar year Australia is down 31 per cent this year in share market value, Europe 33, America down 32 per cent. Has that got a long way to run?
PROFESSOR STEVEN KEEN: Unfortunately yes. The American market is more over valued than we are. Australian stock market isn't as big as... the bubble there isn't as big as the American stock market bubble got to be.
But in the case of Japan again... the Nikkei was 38,500 points right at the very end of 1989, and fell down to 7,000; it's now bouncing around 10,000 having reached 15,000. That's the scale of drop we can expect to see in America; and it's the same scale of drop they got back in 1929 when it fell from 380 to 44.
KERRY O'BRIEN: Very briefly your best case scenario for Australia out of this; your worst case scenario?
PROFESSOR STEVEN KEEN: Best case scenario is a recession more severe than 1990 and lasting one and a half times as long.
Worst case is something up to the level of the Great Depression which was 20 per cent unemployment and lasting up to a decade.
KERRY O'BRIEN: What's your advice to individual Australians right now?
PROFESSOR STEVEN KEEN: Get out of debt, simple as that.
KERRY O'BRIEN: It is not that simple though is it?
PROFESSOR STEVEN KEEN: It isn't that simple, it takes difficult decisions to get out of debt, but that's the only thing to do.
If you're liquid and if you have a secure job, you will do well out of the coming environment, but if you are not liquid, if your assets are tied up and your job is at all vulnerable, then it can be dark times ahead.
But it involves political shift; we have to get away whether the acquisitive society we've been part of, which really is driven by speculation rather than genuine production.
KERRY O'BRIEN: Steven Keen thanks for talking with us.
PROFESSOR STEVEN KEEN: You're welcome Kerry.