June 09, 2012
Wild ride ... harried traders at the New York Stock Exchange. Photo: AP
Australia's economic resilience is being tested as never before, with Europe and the United States stymied by economic pain, write Jessica Irvine and Matt Wade.
THEY say fear can turn on a dime. This week it did.
A feeble jobs market report in the United States sent the Australian sharemarket shuddering into reverse thrust on Monday. It took an interest rate cut followed by the strongest Australian economic report card in four years and bumper jobs figures to turn it around. And turn it did, as the complete cycle of fear and hope distilled into just one week.
The $22 billion slashed from the value of the share market on Monday had been more than restored by week's end. The Australian dollar, which slipped below parity with the greenback last month, tumbled to an eight-month low of US96¢ on Monday. But by Thursday night it had briefly regained parity.
The Treasurer, Wayne Swan, displayed almost dizzy pleasure on Wednesday, welcoming a cracking economic growth rate of 4.3 per cent, driven not only by strong mining investment but also household consumption.
A day earlier, the Treasurer had heralded the benefits of lower interest rates after the Reserve Bank decided there was scope for another cut. Then, on Thursday, came news that the economy created about 40,000 new jobs last month, all of them full time.
''We are an island of growth in the middle of global uncertainty,'' Swan told an assembled press pack in Parliament House in Canberra after the national accounts on Wednesday. He appealed for the figures to be ''an extraordinary circuit breaker in the national discussion''.
''This result says something very special about Australia, and it says something very special about our people, about our resilience, about our hard work, and about our capacity to face up to the worst that the world can throw at us. It does all of those things. Yes, we do have challenges, but what we see here is resilience."
Australians have many factors to thank for this relative economic resilience in the face of the most serious global ructions since the Great Depression.
By way of fortune and geography, the Australian economy is ideally placed on the major geo-political fault line of the 21st century, the shift in world growth towards Asia. Buried deep beneath the ground in Australia lie the raw materials needed for the industrialisation and modernisation of the Chinese economy. We've got the goods.
But it's not simply dumb luck. Economic reforms over the past three decades have delivered an open and flexible economy, able to respond to shocks. The reduction of tariffs, the floating of the exchange rate, the decentralisation of the labour market and the deregulation of the banking system have all helped Australia navigate the current uncertainty. Reforms of the 1980s and 1990s, spurred by the perception that Australia was an old economy, home to the ''Pacific peso'', have borne fruit in a new age of uncertainty.
Policy makers have also stepped up the challenge more recently. Australia's fiercely independent central bank has pulled on the monetary reins in the good times, leaving it plenty of ammunition to fire against uncertain global events, as it did by cutting interest rates last week.
Swift fiscal stimulus also helped shelter Australian jobs and growth in 2008 and 2009.
But, for all Australia's achievements, it is not, as Swan is constantly reminding the nation, immune to international developments. In the past month there have been signs the world is re-entering the economic danger zone. There are worries about the three great engines of global growth - the United States, China and Europe. A bust in any one of them could bring the world economy to its knees. All three, and it could spell disaster.
Ironically, the catalyst for this week's share sell-off - the prospect of US economic stumble - is of the three potential crises the one Australians have least to fear from.
Jobs figures released last weekend found the American economy created half the number of jobs expected last month raising the fear of a ''double dip'' recession in the world's largest economy.
It's now five year since the strains in America's housing market became clear with the eruption of the sub-prime, or low doc, lending crisis in 2007, which morphed into global financial crisis when the complex financial engineering claimed the scalp of Wall Street bank Lehman Brothers.
Millions of Americans have since lost their homes and another 700,000 are expected to by year's end. House prices have fallen about 40 per cent and the housing market remains moribund. The US Federal Reserve slashed its lending rate to zero in 2008 to stimulate growth, but it was too late; the US economy was in recession. The Federal Reserve chief, Ben Bernanke, assured lawmakers on Thursday night he intended to keep them there until 2014 at least. He stopped short, however, of announcing a third round of quantitative easing (printing money), as markets had hoped. Instead, he turned the spotlight on Capitol Hill, arguing fiscal policy presented a ''significant threat to the recovery''.
Deeply mired in debt, with ballooning health costs and expensive military adventures, the US government has struggled to breathe life into a flagging economy, leading many commentators to speak of a ''lost decade'' in the world's one-time commercial powerhouse. Multibillion-dollar stimulus packages, while helping at the margin, have failed to stop the US jobless rate remaining above 8 per cent.
The dysfunctional nature of Congress was revealed in last year's crisis over legislation needed to increase the US government's debt ceiling. A default on US government debt was narrowly avoided in return for spending cuts. Fiscal policy is now at risk of being severely contractionary, with looming spending cuts presenting a ''fiscal cliff'' over which economists fear the US economy will be thrown. There are signs of stabilisation but a renewed recession would have a knock-on impact on US demand for Chinese and other Asian exports. That's where it begins to get serious for the Australian economy.
China has added to the global jitters. Authorities are making an effort to "rebalance" the economy away from its dependence on investment - especially in real estate - towards consumption. Property prices, borrowing and industrial activity have fallen and the belief that China would grow at 9 per cent or 10 per cent forever has been shaken. The Chinese central bank this week cut the benchmark one-year lending rate for the first time since 2008.
Managing China's historic economic transformation is a huge challenge for policy makers and there's a significant risk the "rebalancing" effort could turn into a hard landing. Meanwhile, growth has slowed markedly in China's giant neighbour, India. A prolonged political crisis has resulted in policy paralysis and reforms to nurture faster economic growth have stalled.
China and other Asian economies have staged a remarkable recovery since the GFC but there are several factors that make the region vulnerable should the eurozone's troubles trigger a major global shock.
The first is trade. Asia is still largely dependent on exports to the West so a recession in Europe will take a toll. "Europe has replaced the United States as the biggest export market for Asia," says HSBC's co-head of Asian economic research Frederic Neumann.
"So a recession in Europe will clearly hit Asian exports. We can already see signs that the sudden deterioration in the economic outlook in Europe in April and May is having an impact on shipments from Asia."
But an even bigger risk might be the abrupt withdrawal of European finance. Growth in emerging Asia is more dependent now on credit than at the onset of the GFC in 2008 and Europe is the bigger foreign lender in the region. If the eurozone crisis deepens, European lenders might be forced to repatriate their investments with serious consequences for Asian growth. "Despite Asia's impressive defences … another bust in the West would hardly leave the region unscathed," Neumann says.
But it is developments in Europe that really keep financial markets awake at night. The roots of Europe's present dilemma lie in its century-long progression towards greater integration and the decision more than a decade ago to create a single currency block.
The currency union opened the floodgates for banks in stronger euro nations to expand their loan books by lending to smaller peripheral nations such as Greece and Portugal. While it lasted, the benefits flowed both ways. German and French banks were highly profitable and peripheral nations had access to credit like never before. Stronger nations such as Germany also benefited from turbo-charged export earnings as the single currency was lower than a German deutschmark would have been.
The union built a dense web of interconnection of debt between euro banks, with little attempt at offsetting fiscal union. When the global financial crisis hit, it exposed the weakness of some euro countries. Greece flat-out lied about its finances. Spain this week conceded it did not have the capital needed to recapitalise banks. The architects of the European Union did not plan for such a day. European leaders have, then, been locked in intense negotiations for several years over the extent to which stronger countries should be called upon to bail out weaker ones and what conditions should be imposed on weaker nations in return for assistance.
Some progress has been made. Bailout packages have been hastily assembled for Greece and a central funding facility established. A haircut on the value of Greek government debt has been arranged. But all is not well. Greeks are revolting against severe austerity measures, the price imposed for bailout. In elections to be held next weekend, Greeks will decide whether to vote for pro- or anti-austerity parties, which could, in turn, determine its fate in the eurozone.
But, as the talkfests continue, a new threat has arisen that could take matters out of the hands of politicians. In what has been dubbed a ''bank jog'' - as opposed to a ''bank run'' - depositors across southern Europe have begun withdrawing funds. Should this accelerate, there would not be enough cash in the vaults to pay everyone. This has led to calls for the European Central Bank to issue eurobonds to raise the funds, or to implement a Europe-wide deposit insurance scheme to stop a pan-European bank run.
On the best case scenario, Europe faces a decade of economic stagnation. At worst, a euro break-up could spark a global contagion and seizing of the financial system to rival the global financial crisis.