Understanding Debt

Monday July 24, 2017 Dr Ganesh Nana

It is with considerable disappointment that New Zealand and many New Zealanders – with political and economic commentators amongst the worst – continue to misunderstand debt and, in particular, New Zealand’s debt situation.


In cases, the misunderstanding is seemingly nurtured by some with a particular barrow to push.  But, in the interests of informed decision-making, a clearer understanding is imperative.


Amongst the most prevalent misunderstanding is the confusion between Government debt and the “nation’s” debt.


Government debt arises from the Government spending more than its income over a period of time and so accruing borrowing to make up the difference.  This borrowing can be from foreigners and/or from other New Zealanders (e.g. households or corporates).


The nation’s debt (aka external debt) arises from all New Zealanders (households, corporates, and Government) spending more overseas than we earn from overseas.


25 07 graph 01


Currently, the Government debt (net core Crown debt) totals $62 billion, or about 23% of the nation’s annual GDP.


This is very low when compared to other parts of the world. Government debt in Japan is well over 200% of its GDP; is over 100% in the US and Singapore; while Canada, Spain, France are around the 90% mark; Germany and India are close to 70%; Mexico at around 50%; China 45%; and Sweden, Hong Kong and Australia near 40%.


Further, Government debt in New Zealand has not been a concern for some time.   Since the turn of the century, it has peaked at 25% of GDP – a trivial figure when compared to the travails in other parts of the globe.


In a nutshell, Government debt in New Zealand is neither high, nor unsustainable. 


In contrast, New Zealand’s external debt is high.  And its sustainability is definitely of concern.  The numbers are sobering.  In net terms, New Zealand’s external debt currently stands at $155 billion, or 64% of our annual GDP.   Promisingly, this figure has declined from being in the 70s (as a % of GDP) at the turn of the century and over 90% of GDP in the early 1990s.


But this remains uncomfortably high with respect to others around the globe.  For example, while Ireland, Portugal and Greece do have ratios well over 100% on this measure, there are not many others at our level that we would want to compare ourselves with.  Closest is Australia at around 55%; Mexico at around 50%; Brazil and the US at about 40%; and France and the UK at 15%.  In contrast, Germany and Japan both register large net external assets, of the order of 40% and 60% of GDP, respectively.


So, critical to any discussion of debt is a clear statement of whose debt you are talking about.  Particularly so in the New Zealand’s situation, where Government debt is in a totally different ballpark to external debt.


25 07 graph 3


Related to the concern about New Zealand’s external debt, is the amount of debt accumulated by the New Zealand household sector.  The debt of the household sector is a large subset of external debt.  Even though households don’t normally borrow directly from foreigners, such borrowing is done via banks.  Banks, in turn, need to borrow from other New Zealanders, or foreigners; with the latter resulting in additions to external debt.  Again, the numbers are sobering, net external borrowing by the banking sector accounts for $110 billion of the nation’s $155 billion net external debt.



Bluntly, the “capital gain” that some (many?) home-owners are currently sitting pretty on is at the expense of a debt to foreigners.  This debt has been wracked up by ourselves, as we buy and sell houses between ourselves at ever-inflated (and, arguably, unsustainable) values.


25 07 graph 03


This buying and selling of existing houses between ourselves does not create any new wealth (in an economic sense), as the existing houses provide the same benefits – keeping us warm and dry, with a place to live, eat, sleep, and play.  But, the inflated values are facilitated by New Zealand households accessing foreign borrowers, albeit via New Zealand banks.


The unsustainability is best evidenced by witnessing the (almost perennial) rise in household debt as a % of our disposable income.  From just over 100% at the turn of the century, it now stands at a record high – a jaw-dropping 167%.


Again, in a nutshell, the worryingly large (and seemingly intractable) external debt of the nation is not closely related go Government debt.  Rather the external debt a result of our (you, me, and other households) own behaviour in propping up artificially high house prices.  This behaviour is funded by us (repeat: households, not the Government) borrowing abroad to support the unproductive capital gains income of property speculators.


And therein lies the second critical misunderstanding of debt.  Yes, it is a four-letter word, but not all debt is foul or offensive.  Critically, it depends on the purpose of the borrowing.


Borrowing to build income-earning assets is defensible.  From a government’s perspective, the income (or pay-off) may well be in the form of a cohesive society, with strong physical infrastructure and respected community institutions that facilitates the well-being of future generations.


For households, borrowing is a necessity during one’s younger years as the ability to earn financial income is restricted.  But, as age and experience assists with the accumulation of skills, incomes (in most cases) will grow and ultimately balance against the previously accrued debt.


Of course, if the borrowing (whether household or government) doesn’t have any pay-off (whether financial, tangible or intangible), then the ensuing debt will leave a very foul taste indeed.


However, for those who see government as an essentially malignant being – to be shrunk to an inconsequential state – then all forms of government borrowing and debt will be an anathema.  This group will invariably talk about our large and vulnerable debt situation and, ipso-facto, argue that Government must slow/stop spending.


For this group, confusion between Government and external debt helps to achieve their goal of a much restricted government.  However, in terms of making informed decisions this confusion is misguided at best; or, unscrupulously mischievous at worst.


For those concerned about the deterioration in the Government debt over past few years, we can rightly point to the need to recover from the Christchurch earthquakes, as well as infrastructure renewal in light of many years of neglect.  With these in mind, the level of Government debt (at around 20% of annual GDP) remains modest at most.


For those truly concerned about our ability to pay our way – or our propensity to ‘live beyond our means’ – then the target is our household sector behaviour.   Arguably, the banking sector, which has been complicit in facilitating such unsustainable behaviour, could be added to the target.


It would indeed seem, though, the height of short-sighted senselessness to starve future generations of much needed infrastructure, in order to placate the behaviour of market participants engaging in speculative – and, yes, unproductive – behaviour.