GLOBAL FINANCIAL CRISIS: by Patrick J. ByrneNews Weekly
Can Australia avoid an economic depression?
, February 7, 2009
Australia escaped the financial crises of recent years; but minimising the impact of the current world-wide meltdown will be a tight balancing act, made more difficult by the nation's huge foreign debt, writes Patrick J. Byrne.Recently, the consultancy Access Economics warned that Australia cannot avoid the recession engulfing the major economies — and the Rudd Labor Government didn't deny the claim.
The United Kingdom has gone into a sharp recession. Its economy has contracted 2.1 per cent since June last year and, with much worse to come, respected economists suggest that the British economy is entering its first depression since the Great Depression of the 1930s.
Prime Minister Gordon Brown has sent an army of public accountants into the banks to assess their vast losses. In an almost impossible task, they are examining "well over a billion items of data for each [British] bank", according to Lord Myners, the minister in charge of tracking down the vast array of toxic securities held by the banks. (UK Telegraph,
January 23, 2009).
The US, UK and Europe hold much of the world's toxic securities, such as those coming from the US sub-prime debacle. An even bigger disaster than the sub-prime is the practice of credit default swaps, valued at $90 trillion worldwide.
According to Kenneth Davidson, writing in the Melbourne Age
(October 16, 2008), Australia's "Reserve Bank 'knows of' about $400 billion of these instruments in Australia. By comparison, the assets of the Australian banks amount to $142 billion". Nobody knows who is holding failing securities or the approximate exposure of the banks.
The British government has made £1 trillion (a million, million pounds) available in bail-outs and guarantees. This hasn't stopped the economic slide as more and more highly complex securities fail, creating as yet unfathomed bank losses and seizing up the credit system. These losses may take many years to pay off.
Following the other big economies, Australia could well see a seizing up of its bank credit system, brought on by falling asset prices (including Australia's highly inflated property market), and an economic black hole as the foreign lending that has financed the nation's foreign debt dries up.
Since the mid-1980s, News Weekly
has warned of the dangers of Australia's burgeoning foreign debt and of financial globalism.News Weekly
has argued it was incongruous to allow the nation to run up a massive foreign debt, while a large savings pool was amassed in superannuation funds. Compulsory super, the larger slice of the more than $1 trillion held by super funds, was allowed to be invested primarily in inflated stocks, property, securitisation and derivatives markets, and 30 per cent was invested offshore.
Meanwhile, the domestic capital market was so short of funds that the banks resorted to borrowing overseas. The net foreign debt today stands at $658 billion, and the gross foreign debt is about $1.18 trillion. Some argue that the latter is closer to the nation's real foreign exposure, because, as often happens in a financial crisis, investments overseas turn out to be worth far less than their valuation on paper.
For over 30 years, News Weekly
has argued for a different approach to Australia's savings and investment, modelled on Singapore's Central Provident Fund. Singapore had compulsory savings for housing, health, education and retirement. The saved funds provided the capital to develop the nation's industries, infrastructure and housing, while eliminating the need for a top-heavy social security system.
Australia should have learned from Singapore and directed some its superannuation savings into a similar range of investments, with the added advantage of providing the capital for keeping strategic industries in Australian hands instead of relying on foreign ownership and capital from countries like China.
Not only are the Australian banks now suffering because of the difficulty in raising funds on the international markets, they are now facing a blow-out of other toxic securities — like the credit default swaps — and a likely slide of the Australian property market, for which they borrowed heavily overseas.
The just released 5th Annual Demographia International Housing Affordability Survey: 2009
indicates that Australia has the worst housing property bubble in the developed world. Historically, Australia's house prices have been three times median household annual income; now it is six times. In descending order are New Zealand at 5.7, Ireland 5.4, the UK 5.2, Canada 3.4 and the US at 3.2 times median household income.
The Federal Government is in a dilemma. If it directs policy to keeping up the property market, it will only prolong the bubble. If it lets the market come down, householders will suffer big losses in wealth, including negative equity, and more toxic debt will fall back on the banks.
This dilemma illustrates the difficulty in steering a successful policy course through this worldwide crisis. There will be no single magic bullet. All policies have their positive and negative impacts.
However, some areas of policy needs are becoming clearer.First,
as the foreign banks forsake Australia, or cut back on their local operations, they are leaving behind a $75 billion black hole — loans that have to be rolled over by medium-to-large enterprises over the next two years and which the foreign banks will no longer be refinancing.
If these businesses cannot find alternative refunding sources, there will be a massive shutdown of business and loss of jobs.
Hence, Prime Minister Rudd has indicated that the government may guarantee the refunding of these businesses, as the Australian banks on their own cannot fill the gap.
The Federal Government, by guaranteeing this funding, is only one step short of establishing a specialist development bank that the media have dubbed a "Rudd Bank", but which Dr Shann Turnbull has suggested should be the Reserve Bank of Australia (RBA) (Letters, Australian Financial Review
, January 27, 2009). As the government's own bank, it could help roll over some of the foreign debt and lend to businesses for infrastructure and housing.
It could make vital funds available without having to rely on taxpayer subsidies and government borrowing, which would add substantially to an anticipated federal budget deficit.
The problem of refinancing the $75 billion in foreign loans is likely to be just the start of a looming bigger problem. Much of the foreign debt is loaned on a short-term (six-to-12 month) basis, and then has to be rolled over. As more foreign funding dries up, more of the foreign debt will have to be repaid.
For years Australians have been told that, as the $658 billion net foreign debt was held by the private sector, foreign debt didn't matter. In fact, it is largely held by the Australian banks.
Now the Federal Government has effectively guaranteed the Australian banks. This raises the question: does the bank guarantee mean that the private sector foreign debt has effectively become public debt? If so, the Federal Government has overnight become the guarantor of Australia's foreign debt and it will have to find a way to finance this debt.
Better to have the RBA roll over these loans, turn some of the foreign debt into domestic debt, have the interest and insurance paid to Australians rather than overseas, and so strengthen the national balance-sheet by reducing the nation's addiction to foreign borrowing.
The Federal Government can fund this process by using its AAA rating to borrow in the markets, or by issuing special bonds to raise funds. (Super industry funds are currently taking big losses and the Federal Government and RBA could offer them security of investment.)
Even the Chanti-cleer columnist in the Australian Financial Review
(January 20, 2009) questioned why governments don't lend directly to the private sector, rather than just to the commercial banks.
The columnist stated: "One can only postulate why governments countenance using taxpayer money (derived by cranking up printing presses) to buy problem assets from banks so they can start lending again rather than simply setting up publicly-funded lending entities to make the loans directly."
related financial issue has already affected the UK and Ireland. Because of the seizing up of their credit systems, thousands of small-to-medium sized businesses cannot even obtain a bank overdraft.
Consequently, even viable, profitable businesses now can't pay wages or creditors, and are laying off staff or closing down, creating a downward economic spiral.
Already in Australia, small-to-medium businesses are finding it harder to obtain credit.
To keep credit flowing, the Rudd government may need to set up an AusBank to keep credit flowing in the economy, to keep small-to-medium sized businesses operating and so avoid workers being unnecessarily laid off.Third
, should Australia's major banks be crippled by overwhelming debt, just relying on big bail-outs won't solve the problem, as Britain and the US have discovered.Swedish model
Policy-makers overseas are examining one successful model developed in Sweden. Its economic crisis arose in the early 1990s when the non-performing loans of its banks were found to far exceed their shareholder capital.
With bi-partisan support, the government guaranteed creditors of all 114 financial institutions, but not shareholders. The government took a stake in the banks in return for new funding, thereby protecting the taxpayer.
The government established a specialist bank, Securum, to take over all the banks' toxic loans and liquidate them over time. A new national agency was tasked with overseeing all banks needing recapitalisation and it ordered them to write down their losses.
The equivalent of 4 per cent of GDP was injected into the banks, and when they became profitable again several years later, the banks were sold off on the markets.
The government and taxpayers made a net profit out of the exercise.— Patrick J. Byrne is national vice-president of the National Civic Council.