Falling private debt levels driving down property prices: Steve Keen

The main point I'd make about the international debt situation as it affects property is something of a curly one.

I'm going to be a bit of a long-winded academic here, but I think I need to do that because otherwise what I say will sound weird compared with the conventional reactions to the US debt "crisis".

Demand in our economy comes from either incomes or the change in debt.

It then buys either goods and services or existing assets.

So there's a link between change in debt and the level of asset prices.

Change in demand – which drives both change in output and change in asset prices – depends on change in income and (drum roll) the acceleration of debt.

This then drives change in purchases of goods and services and change in demand for existing assets.

There is thus a link between the acceleration of debt and change in asset prices.

The conclusion is that for asset prices to rise (including of course property), private debt levels have to accelerate.

That in fact has been happening for the last 20 years in Australia – and that's when the biggest boom in house prices occurred.

Now that the global economy has private debt levels falling, private debt is decelerating – and that's the primary factor that is causing share and property prices to fall.

In all this, the shenanigans over public debt are a bit of a sideshow.

Public debt is rising not because governments are being irresponsible now, but because the private sector was during the subprime bubble (and its equivalents in Iceland, Ireland, England, Spain, and Australia to name a few).

Now that the private sector has gone from gambling on rising asset prices with borrowed money – which drove asset prices up – to reducing its debt, both sales of goods and services and asset prices are plunging.

That necessarily causes government deficits to rise, tax receipts fall and welfare payments increase.

That's what mainly caused the US public debt to blow out.

Private debt fell from 300% of GDP to 258% in the last two years; public debt increased from 60% to 100%.

The US “debt ceiling” thing too is a bit of nonsense: the US has hit and moved its ceiling more than 100 times since World War II.

It's sometimes involved brinkmanship between the Republicans and the Democrats; this time has been amplified by all the Tea Party types.

I don't believe this crisis can be stopped by government spending, but I do believe that if the government tries to cut its spending while the private sector is also deleveraging, it will make things worse rather than better.

So the austerity measures being imposed around the globe will amplify the impact of private sector deleveraging on reducing property and share prices.

Steve Keen is an associate professor of economics and finance at the University of Western Sydney. He maintains a blog on the economy, Steve Keen's Debtwatch.