What I wrote on Budget day: International
My response to the Budget’s international outlook
A lot of things have changed since the 2009-10 budget. But in one respect, things remain the same. The international economy is in crisis, and the pace of change is such that any assessment runs the risk of being out of date by the time it comes back from the printers.
The Budget papers include some discussion of the economic and fiscal crisis in Greece and the rest of the Southern European periphery. But, inevitably, the assessment of the international outlook reads as if it was settled some time in April. There have been some dramatic events since then, with new risks and new possibilities emerging. These events have been reflected in dramatic fluctuations in global financial markets, with last weeks Wall Street plunge and yesterday’s equally surprising surge.
The plunge reflected an assessment that the package of loan guarantees for Greece, painfully stitched together by the EU and IMF would not be sufficient, either to prevent an eventual Greek default or to stop contagious panic spreading through Southern Europe and beyond. Underlying this assessment was the assumption, well justified by experience, that the EU would be slow and indecisive in response.
The announcement over the weekend of a stabilization fund with resources of more than a trillion dollars turned that assumption on its head. The fear that the EU periphery might be cut adrift suddenly abated, to be replaced by a concern about whether the EU as a whole can manage the task it has taken on. Almost certainly that will require a more expansionary policy from the European Central Bank, which fortunately has a fair bit of room to move. In addition, there will need to be a substantial surrender of national economic sovereignty, already imposed on Greece as part of the austerity package. Finally, the central role of irresponsible lending practices on the part of major European banks will have to be taken into account.
What does all this mean for Australia. The direct implications are relatively modest, at least assuming the EU rescue package holds together. But the entire episode is a reminder that the global economic environment is far less stable than it seemed a few years ago. Problems in obscure corners of the global economy, such as subprime real estate in the US, or Greek public debt, can suddenly grow and metastasise into systemic threats.
The biggest concern for the Australian economy is that some similar development might take place in China. Our near-miraculous escape from the impacts of the global financial crisis is largely due to the fact that China adopted stimulus policies on a scale at least as large, relative to the economy, as in Australia.
But the Chinese economy has all sorts of vulnerabilities, including reliance on an overheated construction sector and opaque business practices that almost certainly conceal a lot of sins. Such sins go unpunished in a boom, but are exposed mercilessly in a recession.
On the whole, the increased instability in the global economy reinforces the government’s economic message. The capacity to use monetary and fiscal policy in response to some unexpected future shock will be enhanced by a rapid return to budget surplus and neutral settings for monetary policy.
It’s impossible, though, to avoid observing that Australia has its own vulnerabilities, which haven’t been resolved. Our housing bubble is still inflating, along with China’s at a time when bubbles everywhere else in the world have burst. And our current account deficit remains higher than is comfortable, reflecting the fact that our savings are insufficient to finance both the mining boom and our predilection for big houses. Policymakers need to be alert, if not alarmed.