Why is Australia $1 trillion in debt?

Why is Australia $1 trillion in debt?

A few weeks ago Australia’s national debt reached $1 trillion for the first time - which sounds like a lot - but it hasn’t happened overnight. Around the same time, the US notched up US$40 trillion - and the effects of that are being felt around the world. So in this Squiz Shortcut, we’ll look at:

• What’s going on with Aussie debt

• How what’s happening in the US impacts us here

• And what this all means for our economy…

🙋🏻‍♀️ This newsletter was written by Anna Pykett and Larissa Huntington

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Squiz the Shortcut

First up, what is meant by Australia’s national debt?
Think of it in terms of the hangover from a public service shopping spree; one we can’t quite cover the cost of. In other words, when the federal government spends more on things like health, defence, education, and infrastructure than it collects in tax revenue, it borrows money to cover the shortfall. That’s called running a budget deficit, and the amount it owes is our national debt.

When was the last time Australia wasn’t in debt?
On 21 April 2006, then-Treasurer Peter Costello announced that our net public debt had been cleared due to successive budget surpluses and the sale of major public assets (like Telstra) during the Howard Coalition Government years. It stayed that way for a couple of years until the Global Financial Crisis (GFC) hit.

What was the GFC?
It was the severe worldwide economic downturn that lasted from 2007 to 2009 which was caused by the collapse of the US housing market and the failure of major financial institutions.

What happened during that time?
The ramifications spread from the US to the rest of the world. It saw many banks incur large losses and then turn to government support to avoid bankruptcy. Millions of people lost their jobs, and the world’s major advanced economies experienced their worst recessions since the Great Depression of the 1930s. 

How did it affect Australia?
The PM at the time, Kevin Rudd, rolled out a series of stimulus packages worth more than $50 billion to help keep the economy afloat. At the same time, his Labor government saw a steep decline in the amount of money it made from taxing Aussies (the biggest drop since the Second World War) due to asset values falling and global demand for our primary resources of coal and iron ore dropping suddenly. 

What was the fallout?
It caused debt to pile up… Fast forward to 2020 and the COVID-19 pandemic struck. Aside from causing a run on loo paper, it led to Scott Morrison’s Coalition Government introducing stimulus measures like the JobKeeper scheme.

Remind me about JobKeeper…
It was aimed at keeping Aussies employed and businesses running by subsidising workers’ wages, but it cost a stack of money - as in, billions of dollars - and so it also contributed to the national debt rising. 

Got it… What else is underneath the high debt?
Another underlying factor is our ageing population. Aussies born between 1946 and 1964 - the generation known affectionately as Boomers - are in the process of retiring. This is a double-whammy for the government in that there are fewer people paying income tax and more demand for it to spend money on things related to health and aged care. So we’re talking outlays on hospitals, aged care facilities, medical subsidies like Medicare and the PBS, as well as the Age Pension.

Anything more to know about?
Other big-ticket areas of government spending are Defence, and the National Disability Insurance Scheme (NDIS). In terms of the former, we’ve ramped up spending due to pressure from the US to increase our defence budget (not as much as they want us to though). And when it comes to the NDIS, the Albanese Government has recently passed legislation aimed at cost-cutting due to it becoming much more expensive than originally forecast. 

So, what are the interest implications of our debt?
As anyone who’s ever had to pay off a loan or credit card will know, borrowing money isn’t free. It comes with added interest, and this is also the case for the national debt. Treasury reports show that this year, more than $29 billion will go on interest alone - making it one of the biggest, and the fastest-growing, expenses in the entire budget... And it’s forecast to rise to more than $42 billion before the end of the decade.

How does inflation factor in?
As we mentioned earlier, during the pandemic when the international borders were shut, Australia and a heap of other countries flooded their economies with stimulus packages to keep businesses afloat, shoppers spending and workers from being sacked. That essentially prompted a surge in spending, which led to higher inflation. 

Is it still a problem?
Yep… If you’ve been following any economic news, you’ll know that inflation is still hanging around and very much influencing the decisions of our policy makers. Our latest update from the Bureau of Stats last week showed that headline inflation was at 3.5%, and underlying inflation, which is the one the RBA keeps its eye on that strips out the wildest price swings to show the real trend - stayed steady at 3.6%. 

Remind me what the Reserve Bank’s target range is for inflation…
It’s between 2-3%, meaning there’s still some work to do to bring it back within that range. One economic lever it can pull is to raise the cash rate (the amount our money costs) which influences the major banks to in turn raise interest rates. The idea is that pricier borrowing means people and businesses have less disposable income to spend, which reduces demand and takes the heat out of price rises. 

Does this apply to the national debt?
Yep… As inflation and interest rates remain elevated, it means anyone borrowing money is going to be hit with the higher cost of paying it back - including the government. 

So who exactly do we owe?
Strap in, are you ready? We’re going to talk about bonds… So, Australia borrows by selling government bonds through a body called the AOFM (the Australian Office of Financial Management) which calls itself the nation’s sovereign debt manager. It sells them to local and international investors, including big super funds.

Back it up… What are bonds?
They’re essentially a financial IOU issued by the government when it needs to borrow money. They’re like loans, but instead of going to a bank, they ask investors or other countries for cash. But as with any loan, they’re agreed over a set period of time in return for regular interest payments. And because Australia has a reputation for always paying on time, we’re seen as a good investment. 

How does it impact the budget?
Put simply, a larger chunk of the budget will be spent on interest bills, leaving less money to pay for services, infrastructure and tax cuts. And if we keep spending more than we earn in taxes, we’ll need to borrow even more to bridge the gap. That said, experts reckon our $1 trillion debt is pretty negligible when compared to most other developed nations.

What does the US owe?
America is in debt to the tune of US$40 trillion (A$56 trillion). That number is larger than the entire value of all the goods and services produced in the US economy. It’s built up over years of spending under both the Trump and Biden administrations, and it’s rising quickly - one economic watchdog group says it’s growing by nearly US$7 billion a day.  

How do we compare?
ABC finance expert Alan Kohler says the American economy is 16 times Australia's, but its government debt is 56 times ours… As a measuring tool, experts say comparing the debt to GDP can help make comparisons between different countries. Gross Domestic Product is the total value of all goods and services produced within a country during a specific period - and the United States’ debt-to-GDP ratio is at roughly 123%, near a record high. 

What’s our ratio?
Aussie national debt makes up 32% of GDP - so you can see the numbers are starkly different. The US debt burden is in the top 10 around the world, according to data from the International Monetary Fund. But countries like Japan, Singapore, Sudan, Bahrain, Italy, Greece and the Maldives all carry heavier debt loads than the US… so plenty of others are dealing with the high cost of borrowing too.

How about our biggest trading partner, China?
China's national debt recently surpassed 100 trillion yuan, or roughly $20.8 trillion. And, as another yardstick, the UK's debt is just shy of £3 trillion, or just over $5.7 trillion. So that gives you an idea why some economists say our debt is quite low in comparison.

Why does what happens in the US matter for us?
Still with us? Good, because here’s why this is creating waves around the world... The US dollar is the global reserve currency, meaning it’s the main form of money that central banks and governments all over the world choose to hold in their vaults to back their own currencies and pay off international debts. And it’s also the most widely used currency for products traded on a global market, such as oil or gold. 

Go on…
When America’s in a large spot of debt with its own massive interest bill, as it is now, it has to offer higher interest rates on its government bonds to entice investors to buy them. Because its currency sets the baseline for interest rates around the world, it’s one reason why we’ve seen global interest rates climbing. 

OK… So what’s the outlook for Oz?
Australia has almost always had to pay a little more than the US to borrow - so when American interest rates climb, ours tend to follow. And because most Aussie mortgages are variable - aka moving up or down with the RBA's cash rate - we feel those shifts pretty quickly, unlike in the US, where home loans are usually locked in at a certain rate for 30 years. But for all the big scary numbers, Australia still holds a AAA credit rating - which is the top tier - even as we crossed the trillion-dollar mark. 

What’s the end game?
As far as whether or not our national debt will ever be paid off in full - governments don't usually clear the whole lot; they roll it over, and lean on a growing economy, so what really matters is keeping that interest bill manageable, next to the size of the economy. 

Got it… What should we keep an eye on?
It’s worth watching how much we’re forking out in interest each year, and whether the debt keeps pace with the economy or starts to outgrow it. Coming up, the US Federal Reserve is meeting on 16 September, and here in Oz we’ll get the next decision from the RBA on the cash rate on 29 September. As with all borrowers, the government will have to wait and see what happens when it comes to interest rates - so that’s a bit of extra context for you when rates time rolls around again…

Onto our Recommendations

Reading: This story in The Conversation explains how Australia’s debt piled up (with helpful graphs and charts). 

Listening: This episode of Rethink by the BBC looks at the power of the US dollar and how it’s changed over recent decades.

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