Why Garnaut is wrong about Australia's debt challenge

Australia does not have a debt problem. Professor Ross Garnaut should stop saying that we do.

Debt is not something that is well-understood either domestically or abroad, as illustrated by the misplaced hysteria after the European sovereign debt crisis. An unfortunate consequence of this is that Australia appears to have developed an almost superstitious fear of it.  

Professor Garnaut’s Melbourne Economic Forum appears to have adopted an unnecessarily alarmist position on Australia, our prospects and our prosperity. Debt is only one aspect of their alarmism, but it’s an important one as we come into what may be a rising interest rate environment. Professor Garnaut’s view, for instance, is that the country is ‘unusually vulnerable to international interest rates rising above their historic lows’. This vulnerability apparently stems from having a private sector that has one of the largest obligations to foreign lenders in the world.  Now this is true. Our net foreign debt position, including the public sector, is about 53 per cent of GDP, which is comparable to many European nations who are net external lenders.

It is not true to say, however, that this represents some vulnerability that should be of concern to citizens. Nor is it something policymakers should try and address at this stage of our development, other than to perhaps redirect some of that spending to more productive ends, such as infrastructure. In any case, the point is, our foreign debt position, private or otherwise, is not something we should be concerned over. The country can easily handle the burden of this debt. This may appear to be counterintuitive, even provocative under our current circumstances: the world has just come out of a debt-fuelled crisis and seems to be lurching aggressively into another (something of a problem, at face value, given Australia’s debt metrics). Yet it is a statement that is objectively true.

Consider that debt by itself is not a social evil. This isn’t to say that it can or should rise inexorably into perpetuity; more that there is a case for its prudent use. Fortunately, in the Australian context, prudence does seem to hold sway. It’s not simply a case of bidding up house prices (although there is certainly an element of that).

Instead, Australians are building national wealth, not only by borrowing to fund our growth and investment, but also by lifting our holdings of foreign assets (direct investment, equity, debt). Foreign assets are rising at a rapid clip, and have basically doubled over the last couple of decades. So much so that the country now holds foreign assets that equate to 100 per cent of GDP. Moreover, we are accumulating this wealth at a faster pace than which we accrue debt.  So our holdings of foreign assets have risen to about two-thirds of our liabilities (194 per cent of our debt). This is up from around 40 per cent in the 90s and 57 per cent in the early 2000s. This why I don’t fear a high Australian dollar. It enhances the wealth of the citizenry and makes our nation strong.

In addition to this, the ongoing costs of this debt are negligible. Currently at 1.4 per cent of GDP, our interest bill is low. Much of our debt is denominated in Australian dollars and where it isn’t, effective hedging techniques ensure that this will remain low in a rising interest rate environment, if and when that should occur. It’s actually a very stable variable historically, hitting a peak of only about 3 per cent over the last few decades.  As a proportion of our exports, our interest bill is at 7% roughly, well below the historical average of about 11 per cent.

It’s a fallacy then, to suggest Australia has a debt problem, or a hangover from a global crisis that we had little to do with. Recall that debt has only really been a four letter word since that crisis and the ensuing problems we saw in Europe.

Consequently, much of what is being advocated by many members on the forum and other commentators, will do more to harm the country’s long-term economic interests. In particular that is true of Professor Ross Garnaut’s policy prescriptions, which seem to focus on large-scale currency depreciation and real wage reductions. Australia does have problems, yet misdiagnosing the challenges the nation faces poses serious problems in itself. Debate is welcome, but a debate centred around objectively false assertions is of limited use.