Australia could be the “first domino to fall” in a global economic crisis for the first time in its 200-year history.
That’s according to economist John Adams, Digital Finance Analytics founder Martin North and Irish financial adviser Eddie Hobbs, who argue Australia’s economy is looking increasingly similar to Ireland’s prior to the 2007 housing collapse.
For nearly three years, Mr Adams has been predicting a looming “economic Armageddon” in which a vulnerable Australia is overwhelmed by an overseas financial crisis due to property, household debt and net foreign debt bubbles.
But as house price falls across the country begin to pick up steam, the former Coalition adviser has revised his view. “Australia has never been the first economic domino to fall during a global economic crisis,” he said.
He points to previous downturns including the 2008 crisis, the 2001 dotcom bust, the 1997 Asian financial crisis, the 1991 recession and the 1974 OPEC crisis, all of which started overseas — from New York to London to Thailand.
Today, he argues, given Australia has one of the highest levels of household debt in the world, and the “stark parallels” between Australia in 2019 and Ireland in 2007, “there is a very logical case to make that Australia may buck this trend and go first”.
So what are the parallels with Ireland?
Australia’s household debt to GDP was 120.5 per cent as of September last year, according to the Bank for International Settlements, one of the highest in the world. In 2007, Ireland was sitting at around 100 per cent.
At the same time, the RBA puts Australia’s household debt to disposable income at 188.6 per cent. Ireland was 200 per cent in 2007, while the US was only 116.3 per cent at the start of 2008.
RBA figures also show more than two thirds of the country’s net household wealth is invested in real estate. In 2008, that figure was 83 per cent in Ireland and 48 per cent in the US. Meanwhile, 60 per cent of all lending by Australian financial institutions is in the property sector.
In 2007, the International Monetary Fund gave the Irish economy and banking system a clean bill of health and suggested that a “soft landing” was the most likely outcome. Last month, the IMF said Australia’s property market was heading for a “soft landing”.
House prices in Sydney and Melbourne have fallen nearly 14 per cent and 10 per cent from their respective peaks in July and November 2017, coinciding with sharp drop-off in credit flowing into the housing sector both for owner-occupiers and investors.
According to Mr North, analysis from other corrections around the world suggests once price falls exceed 20 per cent it can create “second order falls as buyers seek to sell”. “Further falls then become self-perpetuating,” he said.
“We have already passed this benchmark in some postcodes like Liverpool NSW (with 23 per cent falls). Plus, we know many households are finding it hard to manage their finances as flat incomes, rising costs and large mortgages create medium-term pressure on many.”
The key indicator to watch is the unemployment rate, currently at 5 per cent. “If this starts to rise, then we know the crisis has started,” Mr North said.
The question then becomes, could an Australian crisis spread?
Last year, UK-based advisory firm Absolute Strategy Research (ASR) warned Australia, Canada and Sweden’s banks posed a risk to the entire financial system, with their combined weight on global share markets four times larger than their share of the global economy.
Investors were “underestimating just how damaging a group of countries that account for just 3 per cent of global GDP can be”, the group said in a client note reported by Australian Financial Review.
ASR said a banking sector that accounted for 20 per cent of the total share market was a “danger signal” in developed markets, citing Japan in the 1990s, the UK in 2003-04 and the eurozone in 2007.
Australia’s big four make up more than 25 per cent of the ASX200 index.
“High house prices, a build-up of household debt post-GFC, and — for Canada, Sweden and Australia — banking sectors that are more than 20 per cent of local market cap and 13 per cent of ‘global banks’ make these markets likely sources of financial market instability in the year ahead,” ASR said.
“The banking sectors in three of these economies have increased in size relative to their own economies and, potentially, in importance in the global financial system.”
The danger is if sharp falls in property prices lead to widespread job losses in construction, real estate and retail, hitting consumer confidence and discretionary spending and affecting Australians’ ability to service their mortgages and other debts.
“Then we could see a domestic property and household debt crash starting to spread throughout the Australian economy and adversely impact the solvency of Australia’s banks,” Mr Adams said.
With Australia’s banks holding more than $38 trillion in derivatives contracts, a significant proportion of which involve overseas counterparties, an implosion in the Australian economy “could send highly disruptive shockwaves throughout the global financial system”.
“Such an occurrence could have profound global implications,” Mr Adams said.
Mr Hobbs, an author and former presenter of TV programs including Rip-Off Republic, slammed “daft” Keynesian money printing policies for the idea that “you can print growth and solve a structural problem of excessive debt with more debt”.
“Those that avoided the GFC bullet unhappily ingested the vast misallocation of mispriced capital that has flowed from global central banks,” he said.
“Australia is top of the pile and is systemically significant. Much like Ireland ingesting mispriced capital caused by the aftermath of German reunification which stoked the Irish bubble, Australia has had a similar steroid after the GFC and precisely at the wrong time.”
Mr Hobbs believes Australia is “likely to be one of the first to crater” in the “destiny with excessive debt that is coming, in the so-called everywhere bubble”.
Australia, much like Ireland in 2007, “may be past the point of no return”. “The next recession is unlikely to be cyclical, short and shallow, but structural, long and deep, and among the outliers may be Australia,” he said. “It will have company.”
AMP Capital chief economist Dr Shane Oliver said while his view on house prices was “quite negative” — he is among the most bearish of the major forecasters, predicting total top-to-bottom falls in Sydney and Melbourne of 25 per cent — comparisons to Ireland or the US prior to the GFC were overblown.
“All up, we’re about halfway through. We do have more downside to go, and that’s going to have a significant negative impact on the economy,” he said. “But I’m not in the camp that says we’re doomed and about to go into recession, and there’s no helping us.”
Dr Oliver said we had “heard these doom and gloom stories lots of times before”, particularly after the end of the mining boom, but those predictions “tend to ignore” the diversity of the Australian economy and the flexibility of Australian authorities to respond.
“There’s plenty of scope for the RBA to cut interest rates, and there’s also scope for tax cuts,” he said. “Whereas if you go back to Ireland, it actually led to much higher interest rates.”
Ireland’s property boom was largely caused by huge capital inflows to the country’s banks, something Australia hasn’t had, Dr Oliver said.
“We have a flexible exchange rate, we’re not part of the euro, we can set monetary policy in response to economic conditions. We’re not like Greece or Ireland. It’s a huge difference.”
He added lending standards in Australia were nothing like as lax as the US, where banks were handing out so-called NINJA loans — no income, no job, no assets — to borrowers who could simply hand the keys back to the bank and walk away.
And while the looming rollover of $120 billion worth of interest-only loans to principal and interest posed a challenge, Dr Oliver said comparisons to US subprime mortgages were off the mark.
“There will be a bit of a drag, but it’s not the same as a subprime borrower who didn’t have a job, didn’t have assets,” he said. “Interest-only is very different to subprime.”
The bottom line, he said, was “we’re unlikely to have forced selling (like) in other countries which causes a spiral”.
Dr Oliver predicts house prices will start to rebound some time next year. Price falls of 25 per cent will bring them back to late 2014 valuations, enticing buyers back to the market. By then we would “probably have two more RBA rate cuts”.
“But that’s a story for 2020,” he said. “We’re not quite there yet.”
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