Welcome to Finance & Fury, the ‘Say What Wednesday’ edition.
Today’s question comes from Brad,
“Any chance you could do a podcast on Australian foreign debt? Is it possible to pay it off? Will paying it off have a negative effect on our economy? Are most or all countries on the path to austerity?"
Brad! Awesome questions as it will flow well into next Friday’s Furious Friday episode. We’ll tackle some of the debt issues here, which actually adds to the structural issues that our economy will face …which might cause some issues in the share market and property market.
But to start off with…What is Foreign Debt?
Foreign Debt is the total of government, financial institution, household and business debt that is borrowed overseas. Australia’s Net Foreign Debt totalled just under $1 trillion last year.
Types of Debt
Gross foreign debt is the sum of all non-equity liabilities by Australian residents, the major component of which is the total amount of borrowings from non-residents by residents of Australia.
Net foreign debt is equal to gross foreign debt minus lending by residents of Australia to non-residents and non-equity assets such as foreign reserves held by the Reserve Bank.
Where has this come from? It’s all behind the scenes.
Most of Australia’s $1 trillion dollars in net foreign debt has been borrowed through the banking system and used to increase home lending. This has helped fuel property price increases. As at June 2017, the banking sector had borrowed some $850 billion from offshore, equating to 49% of Australia’s GDP
With a lot of our net foreign debt tied up in the financial system (especially in home/property lending) there is going to be a bit of an issue if we lose our AAA rating and the cost of borrowing goes up. Essentially then it will be up to us to pay this debt off rather than the government, especially given the new Bail-In laws (whilst I touched on this slightly last week I will cover more thoroughly in another episode). I doubt the Government would need to do anything in regards to Austerity to pay back this debt as they can take over banking operations.
What does all this mean?
What if this happens? What happens when nobody wants to lend anything more, or we can’t afford the repayments?
Foreign Debt Austerity (not really relevant to this)
Let’s look at Government debts as this is where Austerity kicks in
What you hear all the time is, compared to other nations, we aren’t in much debt compared to GDP at the national level, so don’t worry!
Say you are in a household, and your household net income is $100,000 (think of this as GDP)
The Government paying off debt
It would be relatively easy if spending was switched back to repaying debt. It comes back to them having three options 1) Tax more, 2) Spend less, 3) Borrow to bridge the debt repayments.
This is where moralistic flavour enters the debates. People think it’s immoral to spend less in certain areas, others think it’s immoral to tax more. Unfortunately, we’ve seen a popular solution to this of taxing the ‘rich’ more. It’s clearly a popular sentiment in Australia too. But isn’t this still picking on a minority of 1-10% of the population. Morality is relative and really depends on what side of the aisle you’re sitting on.
The biggest growth in spending, and easiest place to reduce spending … is Welfare!
This leads to the bigger point – Why does every nation seem to be indebted?
Total Levels of Debt
The History of Australian Debt.
Debt has risen massively and with nothing to show for it. Currently we have lower historical wage growth than what we had when we weren’t borrowing as much. GDP growth is a lot less as well.