Our theme in early 2010 was 'guarded optimism'. But the economic outlook has darkened since then and there are several major pressure points that could create serious trouble.
The summary in early 2010 was as follows.
* No-one with any sense of history could be surprised by the near-misses experienced in 2007 and 2008.
* Now we see a tepid recovery in most western nations and a strong rebound in the developing nations. No-one should be too surprised if a fresh shock reverses these improving trends.
* The view expressed here is one of guarded optimism. While all governments fail to prevent booms turning to busts, and most analysts fail to provide unambiguous warnings, governments and central banks acted quickly and decisively in 2008 in ways that John Maynard Keynes – economic policy’s great innovator – would have been quick to recommend.
* If there is a fresh shock, governments and central banks will again apply the Keynesian remedies. Whether repeated doses of the Keynesian medicine would be as effective as they currently appear to be, is one of the great questions. At present the US budget deficit has trillions of dollars of red ink (that is, budget deficits) ‘as far as the eye can see’. With similar deficits throughout the western world, there are serious impediments to further stimulus.
* Already in the US, Main Street is angry that Wall Street was bailed out with taxpayers’ money and the issuance of government debt; future taxpayers’ money.
* A taxpayers’ revolt could limit government’s freedom to act, or demand faster ‘red ink’ reduction. Taxpayer concern at the massive debts could lead to frugal behaviour by households and businesses, keeping private economic activity subdued for years. Japan’s two decades of permanent recession following its great stock market crash that began at the very end of 1989 is a warning example.
* Another shock ... would strengthen all these understandably adverse reactions.
(The full essay is available here.)
Even as a 'guarded optimist', Henry in early 2010 was concerned at the possibility of further shocks. Now the odds of further shocks have risen.
1. Potential shock number 1. Now there is a slow moving train crash that is very likely to destroy the Eurozone and create the 'another shock' that Henry was worrying most about in early 2010. Here is a recent account by historian Niall Ferguson and Henry's comments on this.
2. Potential shock number 2. The American 'Supercommittee' charged to resolve America's unsustainable budget deficits is reported to be still divided on political lines. Republicans want to slash spending, especially Democrat programs of social welfare and healthcare. Democrats insist that taxes must be raised, but are willing to do most of the work by closing loopholes that allow the richest Americans to pay less than the middle classes, whose budgets are under great strain. Sensible economists argue that both spending cuts and tax hikes (especially on the wealthy) are needed, Failure of the committee to agree on a sensible program would create another shock.
3. Potential shock number 3. Can China continue to grow at double digit rates with recession or very slow growth in Europe and the USA on top of its own anti-inflation policies? 'Not bloody likely comrade' is the answer, and a slowdown in China's growth would be a third economic shock. The onset of even one of these shocks might raise the probabilities of the others.
So Henry's 'guarded optimism' of early 2010 is replaced by a darker picture. Even in the absence of one or more of these three shocks, the best case is slow growth or worse in the USA and Europe and pressure on China to replace export growth by domestic growth.
In this darker world, what are Henry's fearless predictions for 2012 and beyond?
Going in 2011 - each 90 % likely or more.
1. The Eurozone. The weaker nations of the Eurozone can only afford to finance some proportion of their swollen official debts and substantial writedowns (defaults) are necessary. The weaker nations need to quit the Eurozone and adopt their old currencies. Debt default and currency depreciation will provide blows to the Eurozone banks, whose liabilities will remain in Euros and whose assets will be in depreciating drachmas and lira. So the banks will need to be bailed out and exactly how this will be achieved is uncertain given the size of official debt and lack of effective political coordination within the Eurozone. Deep and prolonged recession will follow, probably followed by serious inflation, as printing money will be the only way to try to stimulate the economies of the former Eurozone.
2. Qantas. Qantas has been 'slowbaked' under the Labor government's Fair Work industrial legislation and its international operations cannot survive in the fiercely competitive, low margin global airline marketplace. Best case is that Qantas international gets merged with an Asian airline and adopts 'global best practice' workpractices and remuneration standards. Travellers need to ask if 'global best practice' applies to maintenance standards.
3. Australia's small mining and resource exploration companies; some will fail, others will lose vitality. The mining tax will tip the scales against the minnows of Australia's magnificent mining industry, and the carbon tax will be another impost that an energy exporting nation can ill afford.
4. The Australian dollar will remain volatile but at some stage will correct dramatically to 70 cents per US dollar, perhaps lower.
5. The Gillard government will recover some further lost ground but nowhere near enough to provide more than a slight chance of securing another term of office. The Coalition will inherit a major fix-up task.
6. Unemployment will be going up, which in economic terms is the hard reality of Qantas going down, small mining and exploration companies giving up and other industries declining.
Weakening in 2012 - 100 % likely
7. Australia's manufacturing, tourism and educational industries will continue to weaken. Some relief will be provided when the Australian dollar corrects dramatically, as it will eventually do, and when interest rates are reduced further, as looks likely.
8. Equity markets will at best be soggy and a major global correction is more than an even money bet.
9. The Labor government's Fair Work legislation will be unable to maintain industrial peace and 'deserving' groups such as very senior public servants, carers, nurses, police, teachers will all get larger wage hikes than Australia can afford. Frank Crean's law that one man's wage rise is another man's job will be proven again and applied also to women - a triumph for equal opportunuty.
10. Australia's pride in being part of a 'miracle economy' will be severely eroded, setting the scene for a swing to conservative governments already evident in the Eurozone, the USA and the Australian states.
A recent article by Treasury Deputy-Secretary Dr David Gruen compares the current resource boom with that of the early-mid 1970s. Dr Gruen demonstrates that nowdays Australia has better policies - a flexible currency, an inflation-fighting central bank, subdued growth of government - and more sensible wage determination processes. But average growth has been lower in the decade since 2002, compared with the eleven years from 1970. See graph below and Read on here.
Chart 4 Growth in non-farm GDP
Source: ABS Cat. No. 5206.0 and Treasury.
What this means is still to be determined, but will become a vital issue, especially if the end of the Eurozone creates a renewed recession in the developed nations and slower growth of the hitherto strongly growing developing nations.
Indeed, now the realistic worst case for the global economy seems to offer the choice between deep recession or serious depression.
The Raff Report - December 2011.