Ausbuy

The Impact Of The Credit Crunch In Australia

April 15th, 2008

When the sub prime mortgage problem started to show itself in the USA various respected media commentators stated that, since most of our exports went to Asia, it didn’t matter. We had decoupled from the USA. Ausbuy felt that this was a load of rubbish and wrote an article to this effect, but even we have been surprised how rapidly the problems have spread round the world. The two largest banks in the world - UBS of Switzerland and Citibank of the USA - have both written off many billions of dollars and the contagion has spread to such countries as Britain, France, Germany and Japan. Given this scenario, it is not surprising that some of the fall out has landed in Australia.

The Reserve Bank was busy trying to drive down inflation by raising interest rates at the same time as many countries were lowering rates in an effort to keep their economies afloat. The cost of raising money on the global wholesale money market increased as lenders demanded a risk premium. Even with this risk premium it became a lot harder to raise money. The dodgy practices which had grown up during the lengthy boom became identified as such and many companies are facing real danger of liquidation.

At the same time Australia has seen a record Balance of Trade deficit which will have to be financed. Once again Ausbuy drew attention to our shocking Net Foreign Debt position in the Financial Review on 13^th December 2007, but the recent deterioration culminating in the record March deficit surprised us. The ability of our commercial banks to borrow money on the global wholesale market to finance this is now looking doubtful and we can see a position where access to credit will have to be rationed as most of the non-bank lenders will already have departed the scene. This, from a national perspective, is a positive move, but there is no doubt that businesses dependant on discretionary spending will suffer. The banks will be faced with increased bad debts and will be forced to protect their position which in turn will lead to increased repossessions and liquidations. These may provoke public criticism but the banks have a duty to their shareholders and the super funds who invested in them.

The optimists in Australia point to our record sales of minerals in increased quantities and prices as a signal that all is well in Australia. This ignores the fact that these minerals are being transformed into goods exported to the USA and Europe as they slip into recession. They also ignore the new mines that will be coming on stream. History tells us that no mining boom lasts for ever. What then?

The credit crunch has highlighted structural problems and legislative weaknesses. Once again the fallacy of industry self-regulation has been exposed. There will always be clever, but dishonest people trying to beat the system. Even when legal controls are in place some organisations will get round these controls. The controls on commercial enterprises in Australia are relics of bygone eras and do not work in today’s global economy. They are also bureaucratic and compliance is expensive for the companies. Even where breaches are identified there has been a reluctance on the part of the regulatory bodies to pursue legal remedies. When they are criticised for this they blame badly framed laws which do not give them enough power and lack of resources budgeted by the government. These may be true, but they have not in the past suggested clearly articulated alternatives. This makes their complaints today sound like excuses.

Companies listed on the stock exchange are governed by continuous disclosure rules which are meant to keep the market fully informed. However, in today’s climate of fear, identification of potential financial problems can easily become a self fulfilling prophecy as potential backers withdraw their support and the company is then forced into receivership.

Band aid solutions or legislation will not work, but it is clear that systemic problems identified must be tackled. Attempts to do so will be resisted both by vested interests and by people who defend free market economics without realising that legislation is required to keep the market free.

There is no doubt that many people will suffer as a result of the credit crunch. Superannuation funds will drop in value along with share prices, houses will be repossessed, companies will go into liquidation, unemployment will increase and the economy will slow. However, we believe that the mineral boom will last long enough to carry out the structural changes required by the new era we are entering into. Perhaps we will see a falling dollar, a resurgent manufacturing sector, increased personal saving and an Australia which is paying its way and not relying on foreign capital. If all this happens we will look back at the credit crunch of 2008 as a turning point in our economic history.

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