Saturday, February 28, 2009

Clues and cluelessness in dear little Australia

The New South Wales jobs summit has showcased just how out of touch the mainstream is with what's bearing down on us. Australia's foremost employment economist, Emeritus Professor Bob Gregory continues to paint a happy face on the situation. I'm sure these guys are inhaling nitrous oxide during the breaks. Along with the great majority of our economic elite he thinks we're just facing a temporary downturn before BAU reasserts itself. So what if China goes from 12% growth per annum to 6%? They'll still want our commodities! So before long the noveau rentier class of baby boomers will see their superannuation rise again and can happily go back to drinking fine reds, riding their Honda Gold Wings and jetting off to Europe once a year.

But there were one or two, or perhaps one and a half warning voices (from the ABC's report)

But one summiteer threw in what looked like a hand grenade to disrupt the group think. This is where the China syndrome as a major flaw in current Australian strategy emerged.

Dr Jonathan West, director of the Australian Innovation Research Centre and just back after 18 years as Harvard University's graduate school of business administration, said there was always one person who disagreed with the flow on the conversation. "I find myself in that position today".

Dr West spoke off the cuff and I've transcribed his remarks from Stateline NSW's camera tape.

"My disagreement rests on a simple proposition. What is the right thing to do about a crisis depends on what's causing the crisis. So it's very important to be clear about what's causing the crisis.

"If, as our federal treasury believes, the crisis is caused by a transitory passing downturn in demand, which is usually driven as Bob (Gregory) pointed out by central bank or government-driven increases in interest rates, then the appropriate reaction is for government to support demand, including by borrowing. And that's what our federal government is doing. It's borrowing money.

"And since we're a net debtor nation internationally it means we're borrowing money internationally ... read, in short hand .. from China. It's borrowing money to support consumption. What is that consumption?

"By and large it's buying goods from China. So we're borrowing money from China ... (I'm using short hand of course. We're borrowing money from a lot of places) ... to give to consumers who use it to buy goods that are no longer made (can no longer be made) in Australia ... from China.

"So we're left with the plasma TV and the debt and China has the jobs and the credit. Now that would be the right policy if the problem, as stark as it sounds, was a transitory contraction of credit due to rising interest rates and therefore a need to support demand. But that is not what's happened."

Historic proportions
Dr West is not an advocate for rebuilding the tariff wall to protect Australian industry and jobs. He said that the GFC - global financial crisis - had occurred because an unsustainable $US66 trillion debt bubble accumulated since 1992 had finally burst.

He directly challenged Professor Gregory's analysis.

"What is happening is a fundamental structural deleveraging of the global capitalist system and it's a deleveraging of historic proportion. That will demand a different policy response than the ones we've seen from the Federal Government.

"The scale of the deleveraging? We reached an historic average level of debt in the global economic system in 1992. Since that time we have added to the global capitalist system an amount of additional debt in constant dollars of roughly $US66 trillion.

"Now if we consider that the US economy is around $US10 trillion to $US12 trillion, depending on which day you're counting it, $US66 trillion is a gigantic amount of additional debt above the average level of debt. And what's happening is we're bringing that debt level down to an historic average. We have too much lending, too much borrowing, and not enough productive capacity to balance it.

"Unfortunately over the last 18 months $US23 trillion in assets - productive assets - to balance that debt have been destroyed by the decline in bond markets in particular but also equity markets and property markets.

"If the crisis is a deleveraging crisis it's very important to understand the implications of that. One implication is it is extremely difficult to predict what will happen next because leverage multiplies the impact of apparently small events.

"How is it that some of the biggest banks in the world can go broke in a few weeks because of a 1 or 2 per cent increase in defaults? How can that happen? The answer is leverage. The Bank of America which is currently fighting for its life - one of the largest banks in the world, one of the largest banks in the United States - is leveraged 47 times. It's estimated that the appropriate level of leverage - debt - for a commercial bank of that type is nine times."

Dr West said that with this bank's debt exposure a one percent increase in defaults therefore did not produce a one percent impact. It produced a 47 per cent change.

"What's happening in our economy will be overwhelmed by these global forces. You take out of the global economy $US66 trillion in purchasing and investment power then you have a structural change that will not go away in a year or two."

Australians seemed to be viewing the GFC as tremors on the surface of the lilypond in their backyards "when the radio is reporting a tsunami is coming".
There seems to be persistent belief amongst Australians at all levels that we somehow occupy some special, privileged position in relation to the rest of the inhabitants of the planet. We're too "nice", too good at sport and too healthy to ever suffer anything like all those other bad-luck places. To go against this belief publicly takes some courage so I congratulate Dr Jonathan West on his stand. And fortunately someone else decided to rock the cosy consensus: Roger Corbett, Reserve Bank board member, director of Fairfax and Wal-Mart had this to say…

"Those macro conditions you (Dr West) referred to, the imbalance of wealth in the world, and the fact that America is really living on credit from China and that credit is going to devalue in the longer term are major macro issues. But I don't think they are going to affect the next six and 12 months in Australia," he said.

"I think there's also another very important macro fact. Today there are 6.5 billion people on the face of this earth. By the year 2050 there will be 9.5 billion people living on the face of this earth and how we all survive and provide our food and share our energy in the future is a dynamic fact. And the fact that Doha (global free trade) has failed is I think a critical issue in the world that will affect that macro picture."

The problems now facing Australia were sufficiently large, said Roger Corbett, that he was calling on all Australian political parties to adopt bi-partisan support for the current stimulus packages and future strategies to protect and create a sustainable Australian economy.
Indeed. One wonders of course who doesn't want to create a sustainable Australian economy. Motherhood statements come so easily to the lips of conference attendees — still all credit to Roger Corbett for at least mentioning some upcoming problems that don't allow an easy chanting of the mantra of Return to Business-as-Usual after a short break to re-organise the investment portfolio. Exactly what he means by "protect and create a sustainable Australian economy" I don't know, especially when paired with support for the stimulus package which I think will be a complete waste of much needed capital. And there are his board memberships: Wal-Mart? Sustainability? That does not compute.

Still, one-and-a-half cheers.

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