Australia’s coming economic crisis

Economist_John_Adams

The Australian economy is gravely ill.

Contrary to popular belief, Australia is suffering the most chronic economic structural imbalances in its history.

Record household debt of $2.34 trillion (especially relative to disposable income at over 190%), record high house prices (especially relative to disposable income), record net foreign debt over $AUD 1 trillion (or 57% of Australian Gross Domestic Product (GDP)) and household savings at a chronically low 2.1% (the lowest since December 2007) have dramatically increased systemic macroeconomic risk throughout the Australian economy.

This also comes at a time when global debt is over $AUD 80 trillion higher than the 2008 Global Financial Crisis and the world is experiencing record high asset bubbles and structural economic imbalances whether they be:

  • the Chinese financial system;
  • corporate debt in the United States;
  • ballooning European and Japanese sovereign debt;
  • Canadian housing debt;
  • the return of risky financial derivatives; or
  • emerging economies with bulging foreign debt, such as Turkey, Argentina, the Philippines or Indonesia (especially those who have taken on loans worth trillions denominated in US dollars).

The causes of these global economic imbalances are several and largely result from the boom which occurred during the 2000s and the short-term band aid public policy approach adopted by policy makers around the world in 2008 to deal with the challenges resulting from the Global Financial Crisis.

In Australia’s case:

  • excessive money and credit creation through ultralow interest rates and lax bank lending standards;
  • skewed tax policies that encourage incurring debt and asset speculation;
  • generous social welfare policies which dissuade savings;
  • productivity crushing regulations and burdensome regulatory costs;
  • uncompetitive industry, trade and industrial relations laws and policies;

has led Australia for over 27 years to generate economic growth based on speculative debt accumulation channelled largely into the housing sector rather than the generation of real productive wealth.

This phenomenon is underscored by the growth in the Australian money supply as measured by what the Reserve Bank of Australia defines as ‘broad money’.

Broad money has grown by 7.5% per annum from 1992 to 2017 and has led to ‘credit to housing’ as a proportion of GDP to grow from 21.08% in July 1992 to 95.23% as of June 2017, while ‘credit to business’ and ‘credit to other personal’ (non-mortgage debt) as a proportion of GDP remaining effectively flat over the same period.

Alarmingly, the total amount of debt within the Australian economy as well as the amount of debt concentrated in the Australian housing sector is larger than the 1880s and the 1920s, the two periods before the two big depressions experienced in Australian history which occurred in 1890 and 1929 respectively.

In short, Australia is in the biggest debt bubble in our national history, at the same time we are in biggest global debt bubble in the history of the world.

From an economic historical perspective, there is no precedent that can be referenced to sustain the argument that current Australian and global economic structural imbalances are sustainable, especially as inflationary pressure emerges in both developed and developing economies alike and as global interest rates continue to rise.

Nor is there is a precedent that such economic imbalances, especially in a rising interest rate environment, can be resolved in an orderly ‘soft landing’ fashion.

Rather, economic history points to the current global situation resulting in an extreme economic event that will impact the global economy and by consequence the Australian economy.

This is why starting in 2016, I have penned articles for several media publications such as The Daily Telegraph, news.com.au and The Spectator Australia as well as have conducted internet-based interviews seeking to warn the policy makers, business leaders and ordinary citizens about the nature of the chronic economic problems facing Australia and the inevitable economic crisis that historically manifested itself resulting from structural economic imbalances.

Such a crisis may manifest itself in different forms and depends on whether the global debt bubble and by consequence Australia’s debt bubble pops or is engineered to continue through ultralow interest rates and expansionary monetary techniques such as quantitative easing.

The spectrum of possible scenarios of how the coming crisis may play out in Australia was outlined by me in a piece for news.com.au on 19 June 2018 titled the ‘Six Pathways to Economic Armageddon’ and I would encourage readers to look the piece up and consider its analysis.

Irrespective of how events may manifest themselves, it is clear that Australian policy makers, businesses and households are neither sufficiently aware or prepared for the most challenging set of economic problems in our lifetime, especially from a financial, psychological or public policy perspective.

To his credit Tim Wilson MP, the Member for Goldstein, is the first and only member of federal parliament to explicitly warn about the coming economic crisis which he did during an adjournment speech on 28 February 2018, by stating:

‘there are a number of warning signs that we need to wake up to…. We have alarming rates of public and private debt, low interest rates, inflated asset prices and excessive public spending.’.

In his speech, Mr Wilson encouraged members of parliament to come to terms with the current economic warning signs and embrace necessary reforms which would lift national savings, unwind current asset bubbles, reduce public and private debt, while promoting productive investment and sustainable economic growth.

Nevertheless, the Turnbull Government and pivotal federal institutions such as the Federal Department of the Treasury, the Reserve Bank of Australia and the Australian Prudential Regulation Authority as well as State and Territory Governments have not yet taken any sufficient policy action which would begin to address Australia’s economic challenges.

With the domestic and international economic data flashing red and federal parliamentarians raising the alarm bells, the question for the business sector is what should business owners and executives be considering as the economy heads into more fraught circumstances?

Unlike our largely lucky escape during 2008-09, the traditional lax Australian attitude of ‘she’ll be right’ won’t cut it this time around.

Business owners and executives can ill afford to put their head in the sand and wish away the mounting debt plaguing the Australian and global economies.

Rather, business owners and executives should take stock of Australia’s structural economic imbalances and consider how these imbalances may impact their businesses and industries over the short to medium term.

Businesses who are involved in international trade or who have operations across several countries have the added task of understanding the economic conditions and potential structural problems of both individual and regional economies, any economic interdependencies which may between economies as well as how these different economies and governments may respond to adverse economic circumstances.

Becoming well versed with the current state of the Australian and global economies, studying economic history and examining the potential economic scenarios which may play out in the current economic context will give business executives a more complete and robust understanding of the risk profile facing their enterprises and their industries.

Business executives should ensure that macroeconomic risk play a feature role in business and contingency planning and considerations should be given to how these economic risks, if realised, will impact the sustainability of the business whether it be from a customer, financial (especially business cashflow), workforce or supply chain perspectives.

Business leaders must be also sufficiently nimble and agile to ensure that they can both respond to rapidly changing economic circumstances as well as identify market opportunities and capitalise on those opportunities ahead of potential competitors.

Risk and contingency planning should also note the speed in which an economic shock or adverse economic news may result in financial markets moving rapidly.

The recent 2000% explosion of two-year Italian bond yields in May 2018 from -0.138% to 2.738% over the course of 2.5 weeks is a clear signal that electronic algorithmic trading combined with financial derivatives can result in sharp rapid market adjustments in light of unexpected developments, whether it be poor economic news, political instability or unanticipated company announcements.

Beyond preparing their own enterprises, business leaders should also seek to engage relevant business groups and industry associations that can take forward concerns about the economy to relevant federal and state public policy makers.

Business leaders should seek to work with policy advocates to formulate policy proposals that would address Australia’s structural economic imbalances and better insulate the business sector from adverse economic events.

In conclusion, Australia, with the biggest debt bubble of its history, continues to sail undeterred towards a looming economic crisis. Business leaders must be alert to the risks and prepare their enterprises for tougher and potential extreme economic circumstances.

John Adams is an independent economic analyst and commentator having written on economic, political and public policy matters for news.com.au, The Daily Telegraph, The Spectator Australia and The Canberra Times.

John Adams is a former economic advisor to Liberal Senator Arthur Sinodinos and is qualified economist with economics degrees from the University of New South Wales and the University of Wollongong.

John can be contacted at john@adamseconomics.com.