ECONOMIC AFFAIRS: by Patrick J. ByrneNews Weekly
Economic crisis parallels the Great Depression
, July 11, 2009
Australia's banks face a foreign borrowing crisis, leaving the nation vulnerable as the global financial crisis tracks a similar path to the early stages of the Great Depression.
In analysing a recent report comparing the current global slump to the Great Depression of the 1930s, associate editor and chief economic commentator at the UK's Financial Times,
Martin Wolf, says the bad news is "this recession fully matches the early part of the Great Depression. The good news is that the worst can still be averted." (Financial Times,
June 16, 2009).
Wolf draws on a recent paper, "A tale of two depressions" (www.VoxEU.org
, London, June 4, 2009) by economic historians Professor Barry Eichengreen of the University of California, Berkeley, and Professor Kevin H. O'Rourke of Trinity College, Dublin. They took June 1929 as the start of the Great Depression and April 2008 as the start of the current recession.
Their key indicators (see Figures 1-5) dramatically demonstrate the similarities between these two crises. Eichengreen and O'Rourke conclude that the current recession is "a Depression-sized event".First
, world-wide, industrial output (Fig. 1) has fallen proportionally to the early stages of the Great Depression. The two economists found that the UK, Germany, the US and Canada experienced falls comparable to the same point in the 1930s, while France and Italy were worse.Second
, the collapse in world trade (Fig. 3) is worse proportionally than in the first year of the Great Depression. This is not due to recent protectionism by nations, but to a sharp fall in the demand for manufactured output.Third
, the collapse in world stock-markets (Fig. 2) is far bigger than in the same period after the crash of 1929.Fourth
, the debts of governments (measured from 1924 and 2004 respectively) arising from bank and corporate bail-outs and from consumer stimulus packages (Fig. 5) are much larger as a percentage of the economy today than at the same crisis point in 1930.Fifth
, on the positive side, the money supply - money made available to the banks from reserve banks and from governments - is considerably larger than after the '29 crash. And the interest rate on money made available from the reserve banks to commercial banks (Fig. 4) is considerably lower than during the Great Depression - over 3 per cent lower.
These huge government interventions to counter the current crisis have been far more aggressive than in the 1930s.
Wolf asks the big question: will today's unprecedented huge stimulus packages by governments and reserve banks "offset the effect of financial collapse and unprecedented accumulations of private sector debt in the US and elsewhere?"
He says that we are seeing, around the world, a race between private sector debt reduction and global rebalancing of demand, on the one hand, and the sustainability of government and reserve bank stimulus, on the other.
He predicts: "Robust private sector demand will return only once the balance sheets of over-indebted households, over-borrowed businesses and under-capitalised financial sectors are repaired or when countries with high savings rates consume or invest more."
But he warns that none of this is likely to be quick. "Indeed, it is far more likely to take years, given the extraordinary debt accumulations of the past decade," he says. "Over the past two quarters, for example, US households repaid just 3.1 per cent of their debt. De-leveraging is a lengthy process."
He adds: "Meanwhile, the [US] federal government has become the only significant borrower. Similarly, the Chinese government can swiftly expand investment. But it is harder for policy to raise levels of consumption.
"The great likelihood is that the world economy will need aggressive monetary and fiscal policies far longer than many believe. That is going to make policy-makers - and investors - nervous."
To date, Australia has not been hit as hard as the other big borrowing nations. The tail end of the mining boom, several stimulus packages and the willingness of foreign lenders to continue feeding Australia's insatiable need for foreign capital have softened the impact of the crisis. For the moment, Australia is seen as a stable democracy and safe haven for foreign capital, compared to many other countries.
However, this could change quickly.
Australia's bank chiefs and others have warned that Australia's heavy reliance on foreign borrowing is making the banking system increasingly vulnerable. Australia's foreign debt has now reached $674 billion, or about 60 per cent of the gross domestic product.
Cameron Clyne, the chief executive officer of National Australia Bank (NAB) recently told the Australian Financial Review
(June 18, 2009) that the nation's "domestic demand for credit considerably exceeds our capacity to save." He said that a far "bigger strategic issue" for the economy than mortgage rate rises was Australia's reliance on offshore money.
Ashok Jacob, the CEO of James Packer's Consolidated Press Holdings, told a Macquarie Group conference in May that "Australia has the most leveraged banking system in the world ... $900 billion in deposits, $1.5 trillion in loans. A shortfall of $600 billion [roughly equivalent to the foreign debt] is going to be rolled over by the major banks over the next four years, which leads to a lot of pressure on the system.
"Most of it will begin to come off in early 2010. In the next 12 months, there is $200 billion of loans to be rolled over by the banks. All this means we are in volatile waters and we have to be very careful," he said.
Jacob asked how Australia could continue to fund expansion of its mining and other industries if it cannot roll over this money. He said Australia needed to finance $210 billion in large-scale capital projects in the next five years.
According to Citigroup, Australia has a loans-to-deposits ratio of 153 per cent, compared to the UK (144 per cent) and the US (110 per cent). Historically, until the 1980s, developed world banks used to have a ratio of 100 per cent. (Australian Financial Review,
June 18, 2009).
There have been several major warnings that Australia's dependence on foreign borrowing is now unsustainable. In 2006 it came from the International Monetary Fund (IMF) and the Australian Prudential Regulation Authority. More recently it's come from Don Argus, chairman of BHP Billiton and a former NAB chief, and Cameron Cline, the current NAB chief.
While Australia's bank savings have been inadequate for domestic investment needs, in fact Australia has another huge domestic savings pool - it's national superannuation system. Australia's super funds hold $1.1 trillion, with about one-third invested overseas.
This is absurd. The nation has a massive savings pool but lacks conduit institutions such as a development bank to channel funds from superannuation funds to investment in major industries like mining.
This has left private banks to raise funds from overseas in order to develop the nation.
This dependence on foreign borrowing, in the face of the world economic crisis, is now putting the security of Australia's banks and economy at risk.
If the banks cannot roll over much of the $600 billion in the next few years, the banks will have to restrict lending, creating a credit crunch which will stifle economic growth. If the foreign debt then has to be repaid, it will have to come from higher interest rates and probably from taxpayers.
It is now vital for Australia's future to establish a development bank to help roll over foreign debt and channel domestic savings into Australia's future national development.Patrick J. Byrne is national vice-president of the National Civic Council.
Barry Eichengreen and Kevin H. O'Rourke, "A tale of two depressions", www.VoxEU.org
, (London), June 4, 2009.
Martin Wolf, "The recession tracks the Great Depression", Financial Times
(UK), June 16, 2009.
"Bank chiefs warn on funding gap", Australian Financial Review
, June 18, 2009, pp.1 and 45.