Batten down the hatches, the waters are still treacherous
Illustration: Michael Mucci
The ominous word ''boom'' appeared last week, in large type, on the front page of the local newspaper. Given the nature of this paper, the word could only refer to one thing: property. While the signals from the property market are mixed, it appears we are springing back to normalcy without absorbing the reality: the global financial crisis is far from over. All the elements are in place for a second crash.
The world has become an economically unstable place, with enormous unresolved issues. Australia's economy is fundamentally sound, but the global economy is fundamentally unsound. Even a good boat can be swamped by a bad sea and Australia, as a middling economy, will be buffeted by forces beyond its control unfolding in the United States, the European Community and Asia.
The Bank for International Settlements, the central bank for central banks, is warning of ''unstable dynamics''. Ominous language. The International Monetary Fund estimates the world's 20 largest economies, the G20, will have a combined debt equal to 118 per cent of their combined gross domestic product by 2014, meaning debt will have exploded by 50 per cent in just seven years. To fund what? In Australia, debt is being used for expansion of the mining sector, which is good, but also for the ill-disciplined spending of the Rudd government and the chronically overpriced housing sector. As a result, Australia's economy is more vulnerable to economic stress from abroad.
The US is running out of time to avoid another crisis. The federal government's Troubled Asset Relief Program is the biggest financial program the US has undertaken, by far, dwarfing all previous government intervention except full-scale war in 1941. Half a dozen large states are technically insolvent. Unemployment remains close to 10 per cent. The housing sector is moribund.
Robert Carling, a former senior official at the NSW Treasury and now a fellow with the Centre for Independent Studies, offers a warning about the scale of American instability: ''The legacy of four consecutive years of inflated deficits will be a level of debt more than 50 per cent higher, as a proportion of GDP, than before the [financial] crisis, and nominal debt of almost $US10 trillion ($10.9 trillion) … debt burden higher than at any time since the early post-World War II years. The difference then was that debt was in steep decline; in the current episode, it is soaring to a new plateau from which there is no prospect of a steep decline.''
Worse, two-thirds of this increased debt is coming from increased spending by the Obama administration, and Congress seems overmatched by the problem. The longer it postpones the painful spending adjustments needed, the bigger the problem becomes because the cost of debt servicing is already beginning to snowball.
''The current fiscal policies contain the seeds of the next global financial crisis with its epicentre in Washington rather than New York,'' says Carling. ''The problem of excessive indebtedness is in the process of being transferred to the public sector. It is not clear how simply passing the problem between sectors can be a solution to anything.''
In the euro zone, another crisis is unfolding. The public debt of Greece is equal to 120 per cent of its GDP. This is much higher than the level of debt when Russia defaulted in 1998.
Greece is only the start of the problem. Britain is running a budget deficit of 13 per cent of GDP, even bigger than Greece, and Britain's largest budget deficit outside wartime, all caused by excessive spending, lending and speculation.
An assault on the pound appears inevitable. It is foreshadowed by the bond market, where the yields on British 10-year gilts are 4.14 per cent, even higher than Italian bonds. Italy is one of the high-debt, high-unemployment economies once dismissed as ''Club Med'' but, now, as their problem infects the entire euro zone, are referred to brutally as the ''PIGS'' (Portugal, Italy, Greece, Spain). The market anticipates social discord in Greece.
The world economy is counting on China, with its billion consumers and hunger for economic growth, to maintain both demand and liquidity to keep the global economy growing. Australia is rapidly becoming an economic colony of Beijing.
But China has its own problems. It is creating an unsustainable asset bubble. It is also going to hit the second great wall of China - water shortages. China will stumble at some point.
Meanwhile, the advanced Western economies, including Australia, are engaged in a massive social experiment which must fail. We have sought to replace the primary economic unit, the extended family, with state spending. This will impose an unsustainable cost on future generations.
While the obvious and prudent response of government in a financial crisis is to provide social and economic shock absorbers by increased spending and borrowing, it is also important not to overreact. If you believe the global financial crisis is still unfolding, the key is not to overshoot, but to conserve resources and policy options.
The Rudd government, as it has proved in every area of major policy, overspent. It threw money around with undisciplined panic when faced with the global economic crisis. We said the same thing at the peak of the storm. In May, when the next federal budget is presented, a debt-reduction and stimulus-reduction program would be the prudent course and help bolster the government's credibility in an election year.