Leading progressive academic economist Steve Keen gained international recognition after he successfully predicted the 2007 global crisis using an alternative macro-economic model built on the pioneering work of Hyman Minsky and Wynne Godley. His new book, “Can we avoid another financial crisis?” argues that the lessons of the crash have still not been learned by the economic policy mainstream, and that a new crisis looms for some highly indebted countries, including Canada.
While most mainstream economists including Alan Greenspan of the US Federal Reserve celebrated the “Goldilocks economy” and macro-economic stability in the 1990s and 2000s, Keen and some close colleagues argued that the long expansion was built on the sands of an unsustainable expansion of private debt relative to GDP. Financial crises result from a strong tendency towards excessive credit creation by the financial sector even as households and businesses become more and more over-leveraged.
Once they happen, financial crises rapidly lead to recessions and high unemployment which are hard to reverse given the high stock of private debt and an over-extended financial system. The timing of such crises is hard to predict, but they can be expected when the stock of private debt is high and the growth of demand has become overly dependent upon the continued expansion of credit.
Keen argues that Canada is now one of a relatively small number of countries notably including China, which are highly vulnerable to a new crisis. These concerns were echoed in a recent paper by David Macdonald of the Canadian Centre for Policy Alternatives, but have otherwise largely been ignored.
Data from the Bank for International Settlements certainly give credence to Keen's concerns about an over-leveraged private sector in Canada. Household debt at the end of 2016 was 101.0% of GDP, very high compared to a large economy (G20) average of just 58.6%. The increase since 2011 was 9.4% of GDP, compared to a G20 average increase of just 0.4% of GDP
The debt of Canadian non-financial corporations stood at 117.3% of GDP at the end of 2016, above the G20 average of 91.1%. The five year increase in such debt was a very large 27.0% of GDP compared to a G20 average increase of 11.7%.
By contrast, total government debt in Canada is below the G20 average (79.5% of GDP compared to 86.7% for the G20), and has risen only modestly since 2011, by 4.7% of GDP. This was despite temporary fiscal stimulus measures implemented during the global crisis.
To summarize, the level of private debt in Canada has reached very high levels compared to other major economies, and both corporate debt and household debt have recently been growing very rapidly from already highly elevated levels. Clearly, the expansion of credit has been a major factor in recent economic growth and has helped maintain household spending despite very weak income growth.
When it comes to the debt of non-financial corporations, the recent increase is something of a surprise given the weakness of real business investment in machinery and equipment and in research and development. A significant part of new borrowing seems to be due to corporations borrowing at low interest rates to finance share buy backs and to accumulate large cash reserves. Large liquid reserves mean that gross debt could be reduced significantly, albeit at the cost of companies continuing to forgo new investment.
The best single measure of overall corporate financial health is the total debt to equity ratio. This has increased from 180.6% in 2011 to 190.7% today, but is not high relative to the long term average and is still well below the level of the early 2000s.
The rapid growth of household debt is of much greater concern since borrowing is concentrated among younger households taking on large mortgages as well as student and credit card debt, while the level of net debt is low among many older and more affluent households. Further, the largest chunk of household assets, housing, is not very liquid.
Statistics Canada data show that household debt in Canada has risen from 60% of GDP in 2000 to over 100% today, with increases to the stock of debt taking place in almost every year.
Some comfort can be gained from the fact that debt relative to net worth has not increased much since 2000, since household assets have increased at almost the same pace as household debt. But most economists now believe that housing prices are highly vulnerable to a major correction, and the same may well be true of household financial assets. If that happens, net household worth is set to fall sharply just as interest rates start to rise, setting the stage for a major macro-economic shock.
Keen is surely right to argue that growth fuelled by the continuing expansion of private debt is highly risky for the overall economy, and that which cannot continue indefinitely will come to a sticky end sooner rather than later. We should heed his advice to be much more tolerant of government borrowing to support the economy as the private sector makes needed repairs to its balance sheets.
Andrew Jackson is Adjunct Research Professor in the Institute of Political Economy at Carleton University, and senior policy adviser to the Broadbent Institute.