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Why are we so worried about household debt?

Why are we so worried about household debt? Stephen Koukoulas asks. (Source: Getty, Yahoo Finance)

The discussion of household debt and how it is meant to be the catalyst for a recession, house price crash or some other melodramatic catastrophe, is one sided, dull and invariably driven by purveyors of snake oil.

Sure, the level of household debt in Australia is higher than it has ever been, and the average Australian householder has more debt relative to their income than just about anyone else in the world.

But so what?

In isolation, this might be scary stuff. A worry. The reason why the Australian economy is at risk of an almighty collapse.

In context, however, there is very little to be worried about given the remarkable level of assets and accumulated wealth that debt is benchmarked against.

In other words, the level of debt is a meaningless number unless it is benchmarked against the other side of the ledger – assets and wealth.

Household debt: Setting the facts straight

Here are some basic facts about household debt and wealth in Australia at the moment.

Household debt is 190 per cent of household disposable income.

Against this, the level of household wealth in the ownership of dwellings is approximately 500 per cent of household disposable income, even allowing for the fall in house prices between the middle of 2017 and the middle of 2019.

In addition to that are so-called household financial assets, which includes things like superannuation balances, bank deposits, direct share holdings and the like. The value of these assets is approximately 430 per cent of household disposable income.

This means the level of gross household wealth is around 930 per cent of income which, quite plainly, swamps the 190 per cent of household debt.

In turn, this means ‘net’ household wealth – which is the sum of all assets minus all liabilities (debt) is approximately 750 per cent of income.

Australian householders’ balance sheet ‘staggeringly healthy’

In the chart below, the blue line is household debt, the green line are household financial assets and the pink line is household wealth in dwelling ownership. The orange line, which is net household wealth, is the pink line plus the green line minus the blue line.

(Source: ABS; RBA)

Quite obviously, the balance sheet of Australian householders is staggeringly healthy.

In fact, net wealth is only fractionally below the record high registered in 2017 having dipped from that record in the recent past as house prices fell.

Twenty years ago, when household debt was under 100 per cent of household disposable income, net household wealth was just 500 per cent of income.

The worrywarts on household debt seemingly frame their miserable, scare-mongering analysis on the fact that householders may be stressed if there is a sharp rise in interest rates or if the value of financial assets cascades or if there is some other disaster.

And to be sure, these risks are there, but they are largely present regardless of the level of household debt.

Nothing to see here

Indeed, the last time there was a genuine problem with household debt and bank bad debts kicked higher, was in the early 1990s recession when household debt was approximately 75 per cent of income.

The level of household debt was plainly not that problem.

Household wealth in Australia is high and continues to trend higher, swamping the growth in household debt. There is a considerable buffer against a market downturn, like the recent dip in house prices or earlier bouts of weakness in stock markets, which had a negative impact on financial assets.

This is not to say the household sector is immune from periodic bouts of weakness. Indeed, the current growth slump is due in large store to sluggishness in household consumption which has been triggered by record low wages growth and a weak labour market.

But don’t forget to remember, the next time you hear a doom merchant highlight high household debt as a problem for the economy, look at the level of assets and make up your own mind whether the problem is real or a gross exaggeration.

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