Thursday, March 24, 2016

The Australian Recession of 2017: Disappointing

Almost came in my jeans when I saw the link to Steve Keen's Get ready for an Australian recession by 2017

Keen claims to be one of the few who says of the crisis, that he saw it coming. And now he's predicting recession next year. This has to be worth a click.

In Australia. Recession in Australia.

Keen writes:

For the last 25 years, Australian politicians of both Liberal and Labor hue have been able to brag that, under their stewardship, Australia has avoided a recession. Those bragging rights are about to come to an end. During the life of the next Parliament — and probably by 2017 — Australia will fall into a prolonged recession.

That's it, except for the graph. Oh, and down under the graph he writes

Click here to read the rest of this post, and here to download the Excel file showing the link between a slowdown in the rate of growth of debt and a recession.

He can do it in an Excel file? Oh! -- oh, excuse me while I go change my jeans.

According to Recognition Lag at Investopedia:

Followers of the market are familiar with the phenomenon of when economists signal a recession in the economy several months after it has actually begun.

Well yeah. If a recession is defined as two consecutive quarters of negative economic growth, it's gonna be six months at least, from when a recession starts to when it is "recognized". A recession doesn't exist until six months after it starts.

Couple weeks back I showed a version of my debt-per-dollar graph, where I extended the 2008-2015 trend out to 2030. I said "We are at the bottom now, ready to go up." I also said something like I don't know where the top is.

But here is Steve Keen, saying he knows where the top is. And he knows a year ahead of time, instead of six months after. Most interesting.

In "the rest of the post" Keen says

... this recession has been set up by the sidestep both parties have used to avoid downturns for the past quarter century: whenever a crisis has loomed, they’ve avoided recession by encouraging the private sector to borrow and spend.

Policy encourages private borrowing. Keen thinks like I think. He says

This credit sidestep has worked because the extra debt-financed expenditure lifted aggregate demand and income well above what it would have been in the absence of a debt binge.


Unfortunately for Australia’s next Prime Minister, there are two catches to this trick. The obvious catch is that getting that much extra demand out of credit necessarily increases debt much faster than it increases income ...

Yes. And the bigger the existing debt, the more it costs to maintain. The more it costs, the more "extra demand out of credit" it takes to offset the cost. As I have it, the bigger the debt accumulation, the faster debt must grow in order to lift aggregate demand and income.


The less obvious [catch] is that when debt is at stratospheric levels that apply in Australia today, total demand falls even if the debt ratio merely stabilises.


Oh. Wait.

If nominal GDP grows this year at the 2.8 per cent rate it has averaged for the last five years, then GDP in 2016 will be roughly $1,634 billion. If private debt continues to grow at its average rate of 6.9 per cent per year, it will reach $3,414 billion — an increase of $220 billion over the year.

Okay. But then

What about 2017, if private debt grows at the same rate as GDP itself, so that the debt ratio stabilises?

What if it does?

The sum of [GDP and new private borrowing] will be ... 4.3 per cent less than the year before.

Yeah... and

This is the inevitable debt crunch coming Australia’s way, but conventional economists are oblivious to this danger because they’ve brainwashed themselves to ignore private debt as just a “pure redistribution”

Yeah, I know. But just because it is "inevitable" doesn't mean it is going to happen in 2017. I don't understand how Keen comes up with that particular date.

The day of reckoning can be delayed by encouraging yet more private borrowing ...

Yeah, I know. As Keen said up top, whenever a crisis has loomed, they’ve avoided recession by encouraging the private sector to borrow and spend.

They have delayed the day of reckoning. So why won't that trick work again in 2017?

The day of reckoning can be delayed by encouraging yet more private borrowing, which the RBA can attempt to do by cutting interest rates, and the government can reduce the crunch by running a large budget deficit. But these are likely to happen after a crisis rather than before it, because our Reserve Bank and our politicians are as oblivious to the dangers of private debt today as Bernanke was back in 2007.

Yeah no. Yeah, those solutions are likely to happen after a crisis, rather than before it. But that doesn't answer the question: How does Keen know -- or why does Keen think -- that 2017 is the year of recession? That's what I want to know.

Here's his conclusion:

The 2016 election could be a good one to lose.

Could be? That's it?

Well that's a little disappointing, Steve.

The first time I read his post, I didn't have all the questions. I heard Keen telling me what I thought he was saying, instead of what he was actually saying. Whatever. I do that a lot.

I went to his Excel file, looking for a sim that shows the cost of debt accumulating so much that the money left over to buy GDP forces us to buy a smaller GDP than the year before.

This is conceptually magnificent. If income drains out of circulation to the point that there's just not enough left to buy a GDP as big as last year's GDP, that is excruciatingly clear evidence of the cost of finance causing recession. Wow. So I worked thru Keen's Excel sheet carefully, to see what he was thinking.

Keen uses a constant rate for GDP growth and a constant rate for credit growth, and a different number for the "final credit growth rate". That "final" number is a low one, 2.8% instead of 6.9%. The same as the rate of GDP growth.

Granted, this is exactly what Keen described. I quoted him, above. And given those numbers, credit growth drops like crazy in the "final" year. The "nominal growth rate" number on the spreadsheet goes negative. And you know what that means: Recession.

You have to think like I think, or like Keen: Look at the money and look at the numbers. Don't get distracted by oil, or by things people say, or all the other realities of life. To my way of thinking, Keen's analysis is satisfying. Except he doesn't explain the sudden change in the growth of credit. He doesn't account for the one thing that I needed to know.

More than a little disappointing. But he has given me something to think about.

Here's a picture of Keen's spreadsheet:

His sheet ends in 2017. If you look at the Credit growth row (fifth from the bottom), the amounts are $180 in 2013, then $193, $206, and $220 in 2016, and then all of a sudden $96 in 2017. That's the change that gives us a recession, in Keen's spreadsheet world. That's the sudden drop that makes the numbers negative in the pink cells. But he got the sudden drop because, for the year 2017, he used the Final credit growth rate instead of the Nominal credit growth rate. (Those two are up near the top of his spreadsheet.)

I don't have trouble with the arithmetic. I understand what he's doing here. He's showing us that if the growth of credit were to suddenly drop from its usual level, down to the level of the GDP growth rate, the result would be a sudden drop in the Nominal growth rate, so severe that we end up in recession.

It's an excellent lesson. But it doesn't explain why he says

During the life of the next Parliament — and probably by 2017 — Australia will fall into a prolonged recession.

I understand that excessive debt is a problem.

I don't understand why Keen thinks we get a recession in 2017.

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