This is the recession Australia forgot to have

14 08 2011

August 13, 2011

Boy, what a turbulent couple of weeks on global stock markets. In Australia, the All Ordinaries lost 3.75 percent over the week ending 29 July only to accelerate and plunge 7.49 percent the following week. This included a free fall of 4.21 percent last Friday. This week has seen some stability return the markets with a mild recovery of 1.70 percent.

Traders don’t appear to have a single clear reason as to why markets around the world started plunging. In Europe, it was feared the sovereign debt crisis would spread to Italy and Spain and with a potentially large European Union member country defaulting. These fears were worsened with EU parliaments going on August holidays and leaving only the European Central Bank on hand to provide bailouts.

In the United States Tuesday Week, Congress had approved an increase to the $14.3 trillion dollar debt ceiling, preventing an unprecedented default of U.S. debt. Under the plan, the debt ceiling would be increased by $2.4 trillion dollars while also cutting about $2.1 trillion in government spending over 10 years. It took a couple of days, but markets started to wonder if the cuts were in fact all it’s “cut” out to be and if ratings agencies would downgrade U.S. debt anyway.

Those fears were realised last Saturday morning, our time, when Standards and Poor’s took the unprecedented move and downgraded U.S. long term sovereign debt to AA+ explaining, among other things, that the $2.1 trillion in budget cuts “fell short” of the required $4 trillion it believed would be required to keep a triple A rating. Over the weekend, all and sundry went to the defence saying the downgrade didn’t really mean anything, but despite all the reassurances, the Dow Jones Industrial Average plunged 5.5 percent in trade on Monday.

At the peak of the turmoil this Tuesday morning, All Ordinaries index of the Australian Stock Market was down 24.4 percent from the high recorded on the 11th April. At close of trade today, the index is down 16.3% from the April highs.

All this rapid global volatility could be seen as the start of GFC2.

Back at home, both Treasurer Wayne Swan and Prime Minister Julia Gillard was trying to comfort Australians at a time when their super funds were evaporating in front of them. Both said the “Fundamentals” of the Australian Economy is strong, we have record low unemployment and low levels of public debt. There was no mention of Australia’s record levels of household debt. It was an eerily feeling, bringing back memories of Kevin Rudd during GFC1 saying “As Prime Minister I will not sit idly by and watch Australian households suffer the worst effects of a global crisis they did not create”.

GFC1 was essentially about high levels of household debt around the world caused by speculation on housing and that lead to quite substantial housing and debt bubbles. The banks required credit growth and used financial engineering through Collateralised Debt Obligations (CDOs) and Credit Default Swaps (CDSs) to ‘protect’ themselves. When it all went wrong, Governments had to bail them out, effectively transferring the debt from private household balance sheets to the Government’s while at the same time trying in vain to stimulate unsustainable economies, creating surging public debts and sovereign debt problems.

In Australia in 2008, house prices were already starting to come of the boil after our own sizeable bubble. We had quadrupled household debt over a period of 30 years, with growth rates exceeding that of our United States counterparts. With so much money being soaked up in debt repayments, there was not much money left for retail and services underpinning jobs.

Recessions are a normal part of the economic cycle. There will be a period where the economy will get ahead of itself followed by a slow down or correction. However today, Governments have decided we can’t have recessions or let markets run its course, instead we must prop up the economy as soon as it starts to look weak. 2008 was the perfect example, despite a local housing bubble and record levels of household debt, the Rudd government gave $900 handouts to prop up retail, and introduced very generous boosts to the First Home Owner Grants. This does nothing to address the underlying problems, namely our high levels of household debt.

As such, when the stimulus wears off, as it is doing now, we have found out that few can afford a home hence demand for housing credit is at all times low. Of those with a house and mortgage, they paid too much and now can’t afford to undertake discretionary spending, hence Retailing is now at the worst it has been in decades. If shops are not selling stuff, and builders not building homes then you could expect jobs will have to start going.

On Thursday, the ABS released job figures showing unemployment has risen to 5.1%. Economists are now forecasting unemployment will rise further in the coming months. On the same day, other data surfaced showing the number of companies placed into Administration has jumped 25% in June, the second highest monthly total on record.

It comes as a welcome relief today to hear Chris Evans, Minister for Tertiary Education, Skills, Jobs and Workplace Relations indicate the government has no plans for bailouts or new stimulus packages despite the fact that Australia’s economy is slowing and unemployment is trending up. Hopefully GFC2 wont trigger another knee jerk reaction from our Government to bailout unsustainable bubbles, effectively propping them up for another year or two.

» U.S. triple-A debt rating cut by Standard & Poor’s – 5th August 2011.
» More companies going to the wall – The Herald Sun, 13th August 2011.
» Government has no plan for new stimulus – Adelaide Now, 12th August 2011.

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