Kevin Rudd returned to full-time Prime Ministerial duties yesterday, although with rather less fanfare than a certain US politician.
Rudd and his staff can’t have had much of a break, if the continuing rumours of the 24/7 Prime Minister are true. In the memorable words of Harold MacMillan, "events, dear boy, events" have continued apace. Over the summer the Israelis have fought a small but vicious war in Gaza, the situation in Afghanistan has continued to deteriorate, and the Russians turned off the gas pipelines to much of Europe — again.
And that’s just the news coming in from the foreign affairs desk. Over at Wayne Swan’s office, the gathering economic storm clouds look more threatening by the day.
On Monday, for instance, we had the latest media release from Australia’s most economically literate PR firm, Access Economics. Calling the federal budget "buggered", the previously optimistic Chris Richardson and his colleagues threw the switch to melodrama and rolled out the colourful metaphors. But, as Peter Martin pointed out, the data unfortunately backs up their alarm. After six months of gradually worsening conditions, the global financial crisis is taking a hold in the domestic economy. Australia is heading for a sharp recession; according to Access Economics, it will be "the sharpest deceleration Australia’s economy has ever seen". Readers of newmatilda.com won’t be surprised: I’ve been bearish on the local economy for some time.
The problems of the Australian economy are due to a mix of local and international factors, sparked by the global financial crisis (which actually emerged in 2007: see this excellent timeline of the unfolding crisis by the Council of Foreign Relations). It began, of course, with the bursting of the US housing bubble, driven by lax lending practices and artificially low interest rates. When that bubble began first to deflate and then to implode in 2006 and 2007, huge swathes of the US financial sector turned out to be exposed to trillions of dollars of bad debt racked up by consumers, mortgage companies, merchant banks and failing corporations.
As economists like Noeriel Roubini and Kenneth Rogoff have pointed out, the current bust is an old-fashioned banking panic, with all the associated economic ruin such crises bring. According to a recent study of 14 severe banking crises by Rogoff and colleague Carmen Reinhart, the damage is nearly always widespread: unemployment rises by 7 percentage points on average, GDP per person falls by 9 per cent while house prices can fall by a third. We may be about to see that pattern repeat in the US, UK, Spain and elsewhere. And in many rich countries, including, perhaps, Australia, demand has dropped so quickly that prices are falling. As Nobel Prize winner Paul Krugman has argued, it’s a return to depression economics.
For a long time, Australian economists and analysts thought, or hoped, that Australia might somehow evade the problems of the US and Europe. One theory was called "decoupling" and suggested in essence that China could ride out a US recession on the back of its own domestic growth. Decoupling has turned out to be a myth, with Chinese unemployment at a 30-year high and some analysts suggesting that its manufacturing and exporting economy will be even more vulnerable to the downturn than the US. Indeed, given the fundamental links between the US and Chinese economies, the pain in China is unsurprising. As the Chinese manufacturing and construction sectors suffer, so do their Australian suppliers in the resources sector like Rio and BHP Billiton.
The second line of defence in the "Australia can avoid a recession" theory was the previous strength of the nation’s macro-economic settings. With interest rates above 7 per cent at the top of the cycle, the RBA had space to cut interest rates swiftly and deeply — which it duly did. Likewise, the surge in corporate profits in the boom years left Wayne Swan with a healthy surplus, even after the profligate years of John Howard and Peter Costello’s Family Tax Benefits and income tax cuts. But the RBA’s swinging interest rate cuts and the Rudd Government’s $10.4 billion stimulus package now look like they have barely touched the sides. Deeper cuts and deficit spending will be required by the time Wayne Swan delivers the next budget. As Jessica Irvine points out in the Sydney Morning Herald, whatever your definition of recession, the pain on the streets will be real.
What can Kevin Rudd and Wayne Swan do? Emergency tax cuts have already been mooted, but a more sensible course of action would be a further extensive stimulus package in the next budget. Australia badly needs any number of sensible public investments geared towards our future needs, in areas as diverse as early childhood, vocational and university education, sustainable energy infrastructure, public and community housing, urban public transport and (if anyone still remembers it), the National Broadband Network.
These are all projects that will raise productivity in the long term, and with demand stalling there is no risk of any "crowding-out" of private investment. Indeed, a bigger spend, with a bigger deficit, may even be preferable to a short-sighted budget-balancing exercise. After all, nothing puts the public finances into reverse like a tanking economy. The more Swan spends now, the more chance we have of avoiding a deflationary spiral.
That is, of course, assuming Australia can avoid a significant housing bust — in which case, all bets are off.
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