Reserve Bank governor Rick Battelino showed just how dependent Aussies have become on debt in his presentation of a report from the Reserve Bank, entitled the Financial Stability Review. After closer examination of actual contents of the report, we think Financial Instability Review is a more accurate description.
Aussies have taken on record debt at a time of record low interest rates. Rising asset values have encouraged it. But what happens when interest rates rise? If asset values fall at the same time that the cost of servicing debt goes up, the gamble doesn’t pay off at all. It costs you dearly.
In his remarks, Battelino said that “deregulation, innovation and lower inflation have simultaneously increased the supply, and reduced the cost, of finance to households, and not surprisingly households have responded by increasing their use of it. Household credit outstanding has risen from 20 per cent of GDP in the 1970s to 30 per cent by 1990, and to around 100 per cent today. Household credit accounted for the bulk – 85 per cent – of the rise in overall credit to GDP over the past 15 years, and household credit now greatly exceeds business credit in terms of outstanding.”
Here’s what he said in a picture:
It is true that an increase in financial assets corresponds with the rise in household credit. People are borrowing record amounts to pay record amounts for expensive homes. It all smacks of a credit-driven inflationary boom. When house prices fall—as they are now in America—the debt remains.
To his…er…credit, Battelino notes a dangerous trend in the growth of household credit. “The household sector,” he says, “is running a highly mismatched balance sheet, with assets consisting mainly of property and equities, and liabilities comprised by debt. This balance sheet structure is very effective in generating wealth during good economic times, but households need to recognise that it leaves them exposed to economic or financial shocks that cause asset values to fall and/or interest rates to rise.”
Markets and Money