Realisation of hard landing ahead for Australia

January 25th, 2009

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History will look at this week as the turning point in the Australian public’s perception of what is to come for the economy. Before this week, the mainstream assumed that Australia was on track to a soft landing (see Soft landing hope built on faulty framework assumptions). But with the release of much worse than anticipated economic data from China, that perception was changed. Prime Minister Kevin Rudd said that (see After 17 years on the way up, a rush back down)

China has been hit much harder than forecasters had predicted, its slowdown will affect Australia.

Last Friday’s The great stall of China in the Sydney Morning Herald (SMH) made it to the screaming front page headline.

Our readers should not be surprised at this news. 12 months ago, we already warned (based on deductive reasoning) that China was facing a major economic correction in Can China really ?de-couple? from a US recession?,

We may be wrong, but our theory is that this may be an epic boom waiting to be a bust. Note: we are not making a prediction here- we are merely expressing our scepticism on the de-coupling theory.

In reaction to this bad news from China, Treasurer Wayne Swan promised bold action from the government. The Prime Minister warned that the tests for Australians are yet to come. On another issue, the government also announced that they will organise a fund to help businesses roll over AU$75 billion of loans should foreign banks pull out of Australia. Again, we had covered that issue in November last year at Effects of retreating foreign banks in Australia.

You can see that the rhetoric from government are shifting from (1) denial to (2) underplaying the gravity of the situation to finally, (3) warning of hard times ahead. Denial, for whatever reasons, is the typical reactions of governments. In China, the government denied the truth to save face. In South Korea, the government even went as far as arresting a blogger whose forecasts of doom were disturbingly accurate. In the US, Ben Bernanke was forced to confess that he was completely wrong on his assessment of the US economy. The captains of the finance industry (including their armies of economists, analysts and forecasters) were deep in their denials too (e.g. see Aussie household debt not as bad as it seems?).

So, our dear readers, how can we trust ‘them?’

Is it too late to avoid a hard landing? We’re afraid the answer is a categorical “No!” As we said in Aussie household debt not as bad as it seems?,

A severe downturn to the Australian economy may or may not be statistically likely, but given the level of unprecedented leverage, you can be sure the impact will not be small. Be sure to understand the concept of Black Swans (see Failure to understand Black Swan leads to fallacious thinking).

The question is, how long and severe that hard landing will be. Our view is that since this hard landing is unavoidably long and severe, the best thing the government can do is to do nothing and let the bottom of the economic cycle come as soon as possible, clearing out the years of mal-investments and structural damage. Any intervention will drag out the pain for longer and postpone the day of sustainable recovery.

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  • Pete

    Well, since the Rudd government is going to guarantee these loans, does that make the chance of default even less? All this government intervention does is:
    – cost a lot of money
    – confuse the hell out of the economy making it volatile
    – save companies that have bad business models

    Now what I am wondering is if the government guarantees loans and so on, does that protect the companies from going under? Or just give them protection from being unable to refinance their loans?

    In the end it seems to me that companies with poor business models will just go further into debt…and all the ones with good business models didnt have too much leverage surely?

    Another question is if the government goes into the banking business, how will it determine whether a company should default, or if the government should lend them even more money? What if a dodgy bank needs a bailout and doesnt give full disclosure of debts…then it asks for more money periodically to cover other debts, over and over.

    Its just a nightmare, governments should not be in the finance business unless they can profit from it.

  • Pete

    Well, since the Rudd government is going to guarantee these loans, does that make the chance of default even less? All this government intervention does is:
    – cost a lot of money
    – confuse the hell out of the economy making it volatile
    – save companies that have bad business models

    Now what I am wondering is if the government guarantees loans and so on, does that protect the companies from going under? Or just give them protection from being unable to refinance their loans?

    In the end it seems to me that companies with poor business models will just go further into debt…and all the ones with good business models didnt have too much leverage surely?

    Another question is if the government goes into the banking business, how will it determine whether a company should default, or if the government should lend them even more money? What if a dodgy bank needs a bailout and doesnt give full disclosure of debts…then it asks for more money periodically to cover other debts, over and over.

    Its just a nightmare, governments should not be in the finance business unless they can profit from it.

  • Zoo

    You can see that the rhetoric from government are shifting from (1) denial to (2) underplaying the gravity of the situation to finally, (3) warning of hard times ahead.

    It happened already in Iceland. It happened in the USA. It happened in the UK. It happened it Europe. It’s like a sick template of steps all these governments have been through so the sheeple don’t panic and start turning up on the steps of parliament demanding a new government.

    Unfortunately, our government can’t afford to prop up up banks and other industries. Down that road lies sovereign debt default. Just look at Iceland to see what’s coming for Australia. It won’t happen overnight, but it will happen.

    PS. Do you suppose a couple of big banks are about to go belly up? Is this what they are warming us all up for?

  • Zoo

    You can see that the rhetoric from government are shifting from (1) denial to (2) underplaying the gravity of the situation to finally, (3) warning of hard times ahead.

    It happened already in Iceland. It happened in the USA. It happened in the UK. It happened it Europe. It’s like a sick template of steps all these governments have been through so the sheeple don’t panic and start turning up on the steps of parliament demanding a new government.

    Unfortunately, our government can’t afford to prop up up banks and other industries. Down that road lies sovereign debt default. Just look at Iceland to see what’s coming for Australia. It won’t happen overnight, but it will happen.

    PS. Do you suppose a couple of big banks are about to go belly up? Is this what they are warming us all up for?

  • Hi Zoo & Pete!

    Pete:

    since the Rudd government is going to guarantee these loans, does that make the chance of default even less?

    Zoo:

    Do you suppose a couple of big banks are about to go belly up? Is this what they are warming us all up for?

    Both of you have a very good point. Government guarantee of bank deposits and loans, at the end of the day, can never ever prevent defaults. But investors and the public treated it as if it is a silver bullet that can put off defaults.

    In reality, Australian banks can still default (see How safe are Australian banks?). The instant this news get spread and before the defaulted debt can be transferred to the Australian public via the government, there will be panic in the financial market.

    We agree with Pete that government interventions cost a lot of money. The maddening thing is that all these money are diverted to non-productive use in the economy.

    Pete:

    Another question is if the government goes into the banking business, how will it determine whether a company should default, or if the government should lend them even more money?

    Good question. Government interventions are inherently unfair. By intervening, the government becomes a judge on which businesses should live and which businesses should die. Precious resources in the economy will then be diverted to sectors of the economy favoured by the government.

    This will encourage corruption on the part of businesses as they try to vie for the ‘favoured’ status of the government.

    Not only that, this opens the door for government corruption- not necessary the Rudd government, but future elected governments.

  • Hi Zoo & Pete!

    Pete:

    since the Rudd government is going to guarantee these loans, does that make the chance of default even less?

    Zoo:

    Do you suppose a couple of big banks are about to go belly up? Is this what they are warming us all up for?

    Both of you have a very good point. Government guarantee of bank deposits and loans, at the end of the day, can never ever prevent defaults. But investors and the public treated it as if it is a silver bullet that can put off defaults.

    In reality, Australian banks can still default (see How safe are Australian banks?). The instant this news get spread and before the defaulted debt can be transferred to the Australian public via the government, there will be panic in the financial market.

    We agree with Pete that government interventions cost a lot of money. The maddening thing is that all these money are diverted to non-productive use in the economy.

    Pete:

    Another question is if the government goes into the banking business, how will it determine whether a company should default, or if the government should lend them even more money?

    Good question. Government interventions are inherently unfair. By intervening, the government becomes a judge on which businesses should live and which businesses should die. Precious resources in the economy will then be diverted to sectors of the economy favoured by the government.

    This will encourage corruption on the part of businesses as they try to vie for the ‘favoured’ status of the government.

    Not only that, this opens the door for government corruption- not necessary the Rudd government, but future elected governments.

  • mariemlm

    no one is naming the Australian banks that “can still default”. Which ones are your predictions???

  • mariemlm

    no one is naming the Australian banks that “can still default”. Which ones are your predictions???

  • Zoo

    Which banks? I posted my two faves over on Steve Keen’s blog comments section in April last year IIRC, and I am sticking with them (though for different reasons now), although ultimately they will all probably go belly up. I don’t think there were any banks worldwide that didn’t drink the crazy juice.

  • Zoo

    Which banks? I posted my two faves over on Steve Keen’s blog comments section in April last year IIRC, and I am sticking with them (though for different reasons now), although ultimately they will all probably go belly up. I don’t think there were any banks worldwide that didn’t drink the crazy juice.

  • Pete

    mariemlm: I think it was ANZ and NAB that are considered most likely, but I am completely with Zoo on the ‘all banks’ thinking.

    ANZ and NAB due to their crazy investments and huge writedowns so far. They appear most at risk at the moment.

  • Pete

    mariemlm: I think it was ANZ and NAB that are considered most likely, but I am completely with Zoo on the ‘all banks’ thinking.

    ANZ and NAB due to their crazy investments and huge writedowns so far. They appear most at risk at the moment.