This post deals with two issues, one macro, one local.
Listening to the debate on the proposed US financial rescue package, I have slowly come to the conclusion that it should (at least from a US perspective) be rejected. I say this for one core reason.
The package mixes together two very different things. The first is the maintenance of liquidity so that financial institutions can lend to each other. This is a good thing. The second appears to be the maintenance of US property values. This is plain silly.
What will happen if the package is rejected? The worst case is that the US economy will slip deeper into recession as necessary corrections for past excesses work their way through. We have seen this before. The right economic answer would be to use monetary and fiscal policy to then expand the real economy.
What will happen if the policy is accepted? At best, it may ease the immediate pain, while leaving the US economy (and Government) saddled with still over-valued assets. The outcome will be slower longer term US economic growth.
Both Australian PM Rudd and Opposition Leader Turnbull are strong supporters of the rescue package. Both have the Australian, not the US interest, at heart. Both are, to my mind, wrong. We do not want a reduction in immediate local pain if the outcome is an enfeebled US.
Australia will survive current US problems. We do have significant structural problems, but they are far less than the US.
Our banking system is sound. Liquidity is a problem because of the flow-on effects of the impact of the sub-prime crisis on international bank lending. However, we also have a very large domestic deposit base. Non-bank lenders have been hardest hit by the collapse in liquidity because they do not have this deposit base. Hence the Government's actions to improve liquidity in this area. Overall, we are not going to see bank collapses even if the banks have to take major write-downs.
Our Government financial position is sound. Even NSW, Australia's basket case economy, has very low debt relative to Gross State Domestic Product. Our Federal Government has a present budget surplus and no debt. The Australian Government system has a whole has great capacity to use fiscal policy without mortgaging the future.
Our trade position is much weaker. However, and here Mr Keating (not one of my favourite people in normal circumstances) deserves credit, we have a floating exchange rate.
We can expect an export hit. Commodity prices will fall, although base demand will continue. Food prices may fall a little, but demand will continue. Service exports will decline. Here I am especially concerned about the education sector because we have built structures that in fact depend upon full fee paying students. If on worst case scenario we get a major decline in this area, all our major universities will need some form of bail-out.
While exports may decline, a floating exchange rate means that the external trade position will tend to adjust with time. We may see a fall in the value of the currency, although this is not certain. Should this happen, there will be flow-on inflationary effects. However, these can be managed.
In all this, both Government and Opposition have been spooked into a short term focus. In my view, now is the opportunity to adopt a longer term perspective. What should we do to build the domestic economy, including especially our infrastructure? What might we do, as we did during the Asian financial crisis, to help our Asian neighbours and trading partners adjust to the crisis?
Take China as an example. Chinese car sales are dropping in part because of price hikes on raw materials. Should the Government in conjunction with our resources sector be looking to lower China's raw material prices to encourage Chinese domestic demand?
I am not saying that we should. I am simply arguing that we need to think about our strength in a more turbulent world.