Raise your hand if you remember “the recession we had to go through.” You show your age if you do.
As we approach this federal election, whoever wins would do well to remember those timeless words from former Prime Minister Paul Keating in November 1990, just as the economy began to slide into the abyss.
The downturn at the time wasn’t nearly as severe as the COVID-inspired crash we’re emerging from now. But the after effects were much more severe and lasted much longer.
Another startling difference was that, rather than an unpredictable pandemic out of our control and wreaking havoc on our lives, the last Great Recession was entirely of our own making.
We didn’t have to have it at all.
And now, the warning lights are flashing. Once again, we seem to have forgotten the lessons of history, and it is entirely possible that Western economies are about to make many of the same policy mistakes that caused the Great Global Recession more than three decades ago.
The stagnation of the 1990s was designed by central banks. After a decade of greed and excess – culminating in a financial crisis triggered by a stock market crash – central banks have decided to rein in hyperinflation with the only weapon at their disposal: interest rates.
They raised it to ridiculous levels and kept it there. In the two years to January 1990, the Reserve Bank pumped interest rates by 7 percentage points, peaking at nearly 18 per cent. Mortgages and commercial loans were much higher than that.
The desired effect was; To be sure, the resulting recession killed inflation. But while the economic downturn officially ended by mid-1991, it took a decade for employment to recover, ruining millions of lives.
Could it happen again?
Bill Dudley sure thinks so.
Dudley, the former head of the New York Federal Reserve, thinks the Fed has waited too long to take action on inflation.
According to Dudley, if the Fed wants to contain runaway rates — which are at 8 per cent which is the highest in 40 years — it will have to raise interest rates to the point that crashes the stock market and forces unemployment up.
“This means that the Fed has to do more to slow the economy,” he told Bloomberg last week.
“The Fed is going to have to tighten enough to raise the unemployment rate, and when the Fed has done that in the past, it has always led to a recession.
“That’s not their intention – they’re going to go into a soft landing – but their chances of falling are very low.”
He seems to have measured the mood correctly.
In a sign, St. Louis Fed President James Bullard said Friday that US interest rates could rise to 3.5 percent by the end of the year — a huge annual increase, given that they were at zero a few weeks ago. It equates to 14 price hikes in one year.
“I would like to get there in the second half of this year,” he said. “We have to move.”
On top of raising interest rates, the US Federal Reserve is looking to withdraw about $95 billion ($128 billion) per month from the economy in an effort to dampen demand. Having pumped more than $5 trillion ($6.7 trillion) in newly minted cash into the economy during the pandemic, it is now reversing course.
American business has an immediate impact on us. If US interest rates rise, that flows to the rest of the world. Just like in the early ’90s.
Why is Philip Lowe shy of guns
If you can believe the money markets, we’re in exactly the same boat. According to their estimates, the Reserve Bank of Australia should plan for more than a dozen rate hikes by the middle of next year – a scenario that will put many of last year’s first home buyers under severe pressure.
It is estimated that about half a trillion dollars are at stake after profligate lending last year to record levels as newcomers plunge, seduced by the prospect of years of ultra-cheap loans.
Last Friday, the bank almost raised the white flag. After insisting for most of the past year that prices will remain on hold until around 2024, the latest financial stability review is cause for some concern.
For months, RBA Governor Philip Lowe has insisted rates will not rise until wage growth kicks in. But the first rate hike is now widely expected to be around the corner, possibly as early as June, putting the RBA between the hammer and the very difficult place it so desperately hoped to avoid.
These two subheadings pinpoint two of her biggest concerns.
“High inflation and interest rates will make it difficult for some borrowers to meet debt repayments.”
Then there’s the following: “Significant declines in the price of real estate or financial assets would be devastating to financial markets and the economy.”
Put simply, accelerated increases in interest rates can lead to severe mortgage stress, the possibility of loan defaults, a stock market crash and…a recession.
Our financial mandarins have for years pointed to the large backlog of overpayments that Australians have accumulated in their mortgage compensation accounts as a convenient buffer.
As the RBA chart below shows, it looks great on an average basis as we have almost 18 months of bank payments. But turning to those who have only recently hopped on the mortgage train – many with six times or more in profits – things look tighter.
The pain is likely to be concentrated among young people.
Is stagnation certain?
The only certainty now is uncertainty. Vladimir Putin’s brutal invasion of Ukraine may have backfired startlingly, showing the incompetence of his armed forces and the hollow structure of his regime. But he threw a curve ball into the global economy.
Inflation was already a problem before the failed attack on its neighbor. Delays in restarting factories along with low inventories and shipping restrictions have hampered the global supply of a massive amount of traded goods just as pandemic stimulus across the developed world has fueled demand.
But the exclusion of Russian raw materials and the disruption of trade links have sent energy, mineral and grain prices into a spin. They are now priced in goods and services across Europe, the United States, and Asia Pacific.
If the global situation is not complex enough, China is already in the early stages of a dramatic economic slowdown. The increasingly futile attempts to eradicate Omicron have led to widespread shutdowns, including 26 million in Shanghai where residents are short of food.
Its economy was already in trouble. Attempts to slow its real estate sector have seen widespread defaults, including in the case of China’s Evergrande, which sent shock waves through the economy. It came on the heels of a regulatory purge of the tech giants that sent the Shanghai stock market reeling.
While Beijing is sticking to its guns with a 5.5 percent growth forecast this year, that appears unlikely.
If there is one potential savior, deteriorating global conditions may prompt central bankers to choose a more cautious course in the next six months than financial markets anticipate.
But the risk of policy errors is rising.