Predicting The Next Debt Bubble Pop Recession

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Includes: RINF
by: Ironman at Political Calculations

Author's Update, 30th March, 2016, 9:46 PM EDT: Steve Keen e-mails a clarification - the output variables in the tool above have been reidentified as nominal and real aggregate demand growth rates rather than as GDP growth rates. It's a subtle difference, but a distinct one that better describes the tool's output!

Last week, economist Steve Keen went on record to predict that Australia's economy would fall into recession in 2017.

In doing that, Keen made a back-of-the-envelope calculation linking changes in the rate of private sector debt growth available with real economic growth available via an Excel spreadsheet.

We were intrigued by the math, so we've converted the spreadsheet math into the simple tool below, in which anyone can play with the numbers to predict how a nation's economic growth might change over the next year based on just a handful of factors.

The default numbers apply for the years 2016 and 2017 for Keen's Australia example, but you're more than welcome to substitute the numbers that apply for other nations or years of interest.

Debt Bubble-Pop Recession Tool Screen Shot with Default Results

Please click here for a working version of this tool. [Note: We've repaired the link to the tool, but if you don't want to click through, the screenshot above shows the results for the default data entered in the tool.]

In the tool above, "Current Nominal Credit Growth Rate" is the rate at which private sector debt increased from the previous period to reach its current value. The "Projected Nominal Credit Growth Rate" is the rate that would apply in the future period under consideration.

The reason why changes in the rate at which private sector debt grows would have predictive power for future economic performance comes down to why people in the private sector of the economy take on debt in the first place. It is because they reasonably expect to have sufficient income in the future where they will be able to make payments without significant problems.

As such, the forward-looking expectations that influence decisions to take on debt in the private sector, and consequently economic growth as a result, serve a similar role to what the expectations for earning dividends in the future do for setting the current and projecting the future value of stock prices. The math involved is certainly very similar.

As for Steve Keen's recession call for Australia, we should caution that he has been famously wrong before, particularly with respect to Australian housing prices, yet at the time he made that ill-fated prediction, the impact of China's massive economic stimulus on the strength of Australia's resource-exporting economy was an unknown factor. China's stimulus worked to significantly boost Australia's economy in 2009 and 2010, helping the nation to avoid falling into recession at that time, which in turn, also helped sustain housing prices.

The rapid deceleration of China's economy today as the remnants of that previous stimulus effort evaporate provides a good argument in support of why a recession in Australia's future has become increasingly likely at this time.

It will be interesting to see what factors might intervene to either forestall or accelerate that scenario. Having gone 25 years without an official period of recession, Australia certainly has lived up to its reputation as the "Lucky Country" through this point in time.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.