Sunday, March 15, 2009

Global Financial Crisis (GFC) into Global Economic Crisis (GFC)

Recently attended a dinner meeting where a former senior economic policy person gave a talk on the global financial crisis (GFC) and its morphing into the global economic crisis (GEC). The speaker’s presentation was clear and informative (and under Chatham house rule). It also did not suffer from the America-centric problems of quite a lot of (particularly American) commentary.
The speaker argued that it was a result of a combination of factors. Global financial imbalances (basically Chinese and other Asian saving flooding into pay for American spending), the development of derivatives way in excess of understanding or law that both spread and obscured risk plus very high levels of leveraging based on the presumption of a rising market. The housing bubbles and US public policy encouraging more lending to the riskier were significant factors in these patterns. With the collapse of Lehman Brothers, this toxic brew became the GFC.

Which, in the middle of 2008, morphed into a global economic downturn that hit all major economies simultaneously. It is the simultaneous nature of the downturn that is adding to the severity since, in previous recessions, different areas of the global economy would be affected at different times and to different degrees. Not so this time, hence the GEC.

Australia is relatively well placed since we have low levels of public debt, our banks are not stressed (i.e. our prudential regulation worked better) and our lending practices have been rather better. (The first home-owner grant may be daft policy in that it increases demand in markets where supply is constrained by official discretions, but at least it does not raise risk levels.) So, for example, when the Reserve Bank cuts interest rates, our banks pass the cut on fairly thoroughly. In other economies, cuts in official interests rates are being passed on much less, since the highly stressed banks use such cuts to improve their operating balances.

The speaker was distinctly unimpressed by the various fiscal stimulus packages from the Rudd Government since (1) the speaker thought they were not well structured as stimuli (suggesting that paying the States to suspend payroll tax would be a much more effective way of stimulating employment), though they were perhaps quite well structured as political tools, and (2) bidding for bonds in a situation where so many major economies are selling bonds to pay for their fiscal stimuli at the same time ran a distinct risk of downward pressure on the Australian dollar exchange rate. Not to mention loading future generations with tax obligations. The speaker also felt that now was not the time to be reversing liberalisation of the labour market (i.e. making the labour market more rigid).

A lively discussion followed. Including an informative discussion of China's situation. The high level of Chinese saving represents quite major structural problems within the Chinese economy.

A good night.

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