The United States financial crisis and Australia

Published as ‘China Syndrome’, Geelong Advertiser, Saturday 20 September 2008, p. 33.

I wonder about the implications of the financial and economic crisis in the United States and the impact it will have on the Australian economy and in particular on our larger business institutions. Will it just result some swingeing cost cutting and the sacking of large numbers of workers or will it produce a little more humility and appreciation that without customers and staff firms are nothing? The environment in which our firms are operating—at home and abroad—is becoming more volatile and so it will require a great deal of courage and resilience to take a longer view rather than a slash and burn approach to costs and services.

So far the response has been predictable with the protected banks cutting staff despite record profits. Telstra has weighed in with another cut of several hundred jobs at a time when its service record is abysmal. The ‘millionaires factory’ that was Macquarie Bank is in crisis as its share price plummets. Given that it played at the risky end of the market during the boom, it is not surprising that it becomes highly exposed when things turn sour. It was always thus in financial bubbles.

Should the market be allowed to take its course? This is the position you would expect the free marketers to adopt. And a case can be made in ‘normal’ circumstances when markets are working? But when you get major market failure, because no one knows the value of the ‘assets’ being considered for trading, it is arguable that the pain to the masses of people whose only involvement in the system is as employees or indirect investors through their superannuation funds will far outweigh the costs of state intervention and regulation.

In previous cases of total panic when confidence in the financial system collapsed some form of external, that is external to the market, action eventually occurred and helped produce recovery. In the major bank panics of 1847 or the first Baring crisis in 1890, the German hyperinflation of 1923 or the Wall Street crash of 1929 that is what happened. In the first case it was the Bank of England which intervened, in the second a consortium of national banks, the third saw the Weimar government intervene and in the fourth we had the Great Depression because there was little or no state intervention until Rooseveldt’s New Deal.

Why should the operations of a casino produce the best possible result, when no one really knows the value of the assets which were being traded yesterday or today? To believe this requires blind faith rather than economic analysis. It can take an external jolt to bring people to their senses and create the breathing space in which a more orderly winding up of financial messes can occur.

The scale of the current crisis is beyond the comprehension of most of us. The concept of a trillion dollars (though that is only a billion in the English rather than the American use of the word) is unimaginable. Globalisation of financial markets means that the scale of operations has been expanded well beyond the capacity of existing regulatory systems which are still based on national units. Though some optimists believe that Australia is ‘decoupled’ from the United States economy and therefore insulated to some degree from the current crisis on Wall Street, the linkages through other major financial centres have serious implications for us.

If the Chinese get spooked about the value of their investments in America which are currently helping to underpin that economy then the crisis in the United States will get significantly worse. The Chinese sovereign wealth fund, the investment arm of the Chinese government, is being asked to help bail out Merrill Lynch one of only two surviving large American investment banks. The chances of the Chinese being able to sustain their rapid export growth if the American economy goes into serious depression are slim and that will rebound on us.

If the response of firms and institutions is solely to take out the costs of the subsequent adjustment on their employees then the existing inequalities in our society will be compounded and it will take even longer for recovery to occur.

The irresponsibility of the current opposition in economic policy only mirrors that in which they indulged when they were in office. In those days however the international system was booming, exports of minerals and energy were growing and wage costs were constrained by Work Choices and the improvement in the terms of trade. Peter Costello might like to believe he was a hugely successful Treasurer, but it would have taken an economic nincompoop to prevent this country from enjoying the world boom of the first decade of the century. Huge surpluses on the budget were generated but frittered away in consumption, particularly in pre-election giveaways rather than in long-term investment in skills, research and development and infrastructure.

The current episode comes on top of some long run trends affecting Australia and one or two short run blips, some of which have been favourable and others adverse. For example, our terms of trade have improved dramatically in the last eighteen months. In other words the price of our exports has been rising while our imports have been stable or falling. This is explained by the demand for our minerals and energy resources on the one hand, and the relatively low labour costs in China and Asia which have held down what we pay for manufactured imports. Look, for example, at the price of an electric drill or a steam iron made in China, or most of the mass-produced clothing we buy.

Sharp fall in the value of the Australian dollar relative to the greenback does not bode well. Less sharp decline against the trade weighted index, but any loss of value removes some of the constraint on inflation which we enjoyed when our dollar was stronger.

Neo-cons and free marketeers are not so noisy just now as the U S government bails out mortgage firms, banks and now insurance companies. The legacy of George W Bush looks more shocking each day. By overplaying his hand in Iraq and not concentrating on Afghanistan and by cutting taxes when the costs of both wars were growing rapidly he helped fuel the boom which led to the current crisis. His successor, whoever he or she is, will have some serious sorting out to do.