Sheltered From Financial Storm

The Age

Friday October 3, 2008

Brian Hartzer

Asian demand for Australian resources will provide a recession buffer, says Brian Hartzer.

WE ARE at one of those pivotal moments in history. Last week we saw the biggest bank failure in US history. Washington Mutual was no fly-by-night organisation. It was 119 years old and was probably America's biggest real estate lender, after the collapse of Countrywide earlier in the year.

US regulators simply moved in and sold it to JPMorgan Chase. Washington Mutual is only the latest victim of a credit crunch that has seen the nationalisation of the two largest mortgage companies and the world's largest insurance company; the conversion of the two surviving Wall Street investment banks - Goldman Sachs and Morgan Stanley - into traditional regulated bank holding companies; and a moratorium on short-selling in major sharemarkets.

All this led to the proposed $US700 billion fund to bail out troubled financial companies, which hopefully will be salvaged in the next couple of days. And then this week we also saw Citigroup buy Wachovia, the fourth-largest banking group in the US and one of the most respected retail banks in the country.

Total losses from the financial crisis that erupted in the US in August last year are now likely to top $US1.5trillion ($A1.9trillion). And banks have lost so much faith in each other that the interest rate spread they are seeking to lend to each other is at a near all-time high.

All of these issues had their conception in one basic idea - that economic outcomes can depend more on what happens in asset markets and less on what happens in the real side of the economy, such as in the manufacturing and labour markets. Not only has the financial side of the economy become bigger, leverage - which is the extent to which debt is used to buy assets - has increased.

So now banks, companies and people are de-leveraging. This simply means they are doing the opposite of borrowing - they are paying down debt and spending less.

In the US, this means car sales are at 1993 levels. House prices, on average, are down 16% for the year; and the sharemarket is down 18% in the US and 25% in Australia since the beginning of the year.

In Australia, though, unlike the US, I'm pleased to say we have a net housing shortage and so house prices have been more stable, although we have seen modest declines in selected areas.

At the same time, there is an equally significant change going on in the emerging economies. The industrialisation and urbanisation of countries like China, India and Brazil means we are seeing a radical shift in the economic map of the world.

For instance, the countries with the largest current account balances include China, Saudi Arabia and Russia. The countries with the largest reserves of foreign exchange and gold are China, Japan, Russia, India and Taiwan. From an Australian perspective, this raises two big questions:

Can the growth we are seeing from countries like China continue?

And isn't the world so interconnected that if the US is in recession then all other countries will have to follow?

The good news is that more than 90% of China's production is consumed domestically, as hundreds of millions of people look to escape poverty and join the middle class. So while we do expect growth in the emerging economies to come off, we expect growth in Asian economies to remain around 7% in 2008, down from 8% last year.

In China, growth will likely slow from 12% in 2007 to about 10% in 2008-09. But I think you would agree that 10% growth in one of the world's largest economies is none too shabby.

This puts Australia in a good position to weather the global financial storm, because China's growth depends on the raw materials and energy resources Australia is a world leader in supplying.

In fact, the biggest "swing factor" for Australia is the extent to which we can address the capacity constraints we face in meeting the demand from Asia and the shifting demands of our own ageing population. If we can address these constraints - in labour, infrastructure and housing - then we will likely avoid the scale and extent of recession in Australia that we will see in the US and Europe.

Put another way, the challenge for Australia is to drive growth while driving down costs. Economists call this productivity. And in Australia, we haven't been doing a good job on this recently. The latest productivity table shows that Australia has dropped from the fifth most globally competitive nation in 2001 to No.19 this year.

Despite this, Australia has another thing going for it. Our banking sector is in very sound shape - probably the best of any OECD country.

All four big banks are profitable, well capitalised, well regulated, and individuals and businesses have voted with their wallets by putting billions of dollars of cash into the banks in short and longer-term deposits. Each of the four majors is AA-rated - four of just 18 left in the world with a AA rating.

Brian Hartzer is CEO, Australia, of ANZ. This is an edited version of a speech he gave yesterday in Melbourne to the American Chamber of Commerce.

© 2008 The Age

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