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economic push and pull « Previous | |Next »
March 15, 2008

Jennifer Hewett, writing in The Australian begins to trace the impact of the global financial crisis on Australia. She says:

that the global credit crunch is paralysing the financial system, rampaging through the Australian stock market, forcing up the cost of doing business and creating havoc with everything from individuals' superannuation accounts to the availability of bank credit. This is not only an issue for a few corporate whiz kids who thought the use of ever-increasing debt would be a permanent magic pudding. Problems in the market turn out to be dangerously infectious.

She adds that the confusion comes because no one can be sure of the result, particularly given most of the experts seem to have been spectacularly wrong about how all this would play out. The argument was that Australia was supposed to be insulated from the economic debacle unfolding in the US thanks to the resources boom powering on regardless, courtesy of China.

She observes that this decoupling theory still has plenty of advocates despite the growing number of sceptics who point to the obvious global contagion of the past six months.

What we have is the impact of two economic forces: the China boom (boosting demand) and global financial conditions (dampening demand). Will the latter ultimately overwhelm the former? Martin Wolf in the Financial Times outlines the common features of financial crises:

They begin with capital inflows from foreigners seduced by tales of an economic El Dorado. This generates low real interest rates and a widening current account deficit. Domestic borrowing and spending surge, particularly investment in property. Asset prices soar, borrowing increases and the capital inflow grows. Finally, the bubble bursts, capital floods out and the banking system, burdened with mountains of bad debt, implodes.When bubbles burst, asset prices decline, net worth of non-financial borrowers shrinks and both illiquidity and insolvency emerge in the financial system. Credit growth slows, or even goes negative, and spending, particularly on investment, weakens.

My guess is that the two speed economy scenario still holds in Australia. Parts of the economy will turn sour during the next year, with rising unemployment, falling house prices, and foreclosure in parts of the economy. The effects of constraining inflation and the credit crunch will come together. Step one is a housing recession--falling house prices that will reduce household wealth; step two is further corporate losses from the credit crunch flowing from more losses in US subprime mortgages; step three is the “credit crunch” spreading from mortgages to a wide range of consumer credit; step four is the downgrading of some financial institutions as too risky.

| Posted by Gary Sauer-Thompson at 1:24 PM | | Comments (2)
Comments

Comments

Gary
The sight of businessmen such as E Stanley O'Neal of Merrill Lynch and Citigroup's Chuck Prince pocketing millions of dollars as they quit companies losing billions in value must stick in the throat of those whose money has been lost.

The US economy is shrinking from falling house prices, job losses and turmoil or meltdown in financial markets. That economy is now in recession.

What is amazing is the regulatory rescue in a free market system of those financial institutions whose recklessness, and brass knuckles risk taking created the current credit mess.

Why save Bear Sterns? Aren't they an anything goes player in the Wall Street mortgage securities business? What if Bear Sterns was on the brink of collapse because of the shrinking value of its assets. It would default on its obligations. Let it die. Isn't that the ethos of Wall Street?

The Federal Reserve is making things up as the credit crunch continues to develope and acute stress spreads.