IS THERE any more surefire way to induce widespread panic than the phrase “don’t panic”? Well, here goes anyway: DON’T PANIC. May as well leave panicking to the fickle souls trading daily in financial markets, if only because they are so good at it. Which is not to say the world economy does not have big problems. It does. This week’s sharemarket dive is not simply the result of herd instinct – although there is a good deal of that, too – but a dawning realisation that the world can’t go back to how things were before the financial crisis.
Around the world, households, businesses and governments borrowed from the future to fuel their growth. And guess what? The future wants it back.
Paying back these debts means a long and painful period of “deleveraging” – paying off debts and increasing savings. This means recovery from the global recession of 2008 and 2009 will take longer, and be less impressive, than that which followed previous recessions.
So where does the growth come from? Global investors are increasingly drawing a blank on this crucial question. They have responded by pulling out of riskier, growth assets like shares and socking money away in government bonds.
The Australian dollar has felt the effect this week, sinking below parity with the US dollar.
So is Australia facing an end to its longest period of uninterrupted growth on record?
Of course anything’s possible; the business cycle is not dead yet, but it is by no means clear the end of growth is nigh.
In any event, if it were clear the Australian economy was heading for a severe downturn, you can be sure the Reserve Bank would move quickly to cut its lending rates. Outside the mining sector, economic growth is already below average. Nest eggs have been destroyed and confidence is already fragile.
What would it take to push the Reserve over the line into cutting rates? First, any sign of a complete seizure of the global banking system would be an immediate trigger. Already banks are charging more to lend to one another. But the wheels of commerce still, for now, keep spinning. And, as the Reserve noted in its Financial Stability Review released yesterday, Australian banks have managed to reduce their reliance on offshore funding by offering attractive rates to domestic depositors. But things can change quickly.
Second, signs of a significant slowing in the Chinese economy would raise alarm bells. The United States is the main destination for Chinese exports and another US recession would be felt in China. And yet, China’s leaders managed successfully during the GFC to replace a drop in exports with increased public spending on infrastructure, such as rail, and by forcing state-owned banks to keep lending to businesses. China’s voracious appetite for Australian mineral resources remained strong. If anything, China’s leader in waiting, Xi Jinping, has even more incentive to keep pump-priming the Chinese economy to ensure a smooth transition to power.
Third, the Reserve would consider cutting interest rates if it became apparent that financial volatility was feeding through into the “real” economy. A sharp rise in the unemployment rate or feedback from businesses that they were cancelling investment plans would prompt concern.
And yet, to date, Australian firms still have plans in the pipeline for investments totalling almost $150 billion this financial year and the jobless rate remains at historic lows.
It’s not immediately clear what the sinking Australian dollar means for interest rates. For a Reserve still concerned about the potential for inflation in an economy operating at close to capacity, a lower dollar removes one disinflationary force – cheaper imports – arguing for steady or higher rates. But for a Reserve increasingly concerned about prospects for Australian and world growth, a sustained fall in the dollar helps build the case for lower interest rates.
One source of comfort to the Reserve, and no doubt for some households, is the increased savings buffer many have built over the past half decade.
Even before the financial crisis – beginning about 2004 – Australian households began saving more and paying down debts. Reserve Bank analysis suggests the trend was widespread, among renters, mortgagees, oldies and young alike.
Coming from a starting point of low joblessness, low public debt and plenty of room for interest rate cuts, Australians are better placed than perhaps any other developed nation to weather this financial storm.