Australia Doesn’t Need a GFC to Have Its Own Financial Crisis

Recent volatility on global stock markets had most investors fearing the worst. Two questions in particular were on everyone’s lips. Where is the global economy headed? And could a repeat of the 2008 GFC be around the corner?

If you’re a glass half empty person like me, the answer bears thinking about. Things not only look bad, but it’s hard seeing the situation improving anytime soon.

The truth is Australia doesn’t need a GFC to have its own crisis. The Chinese cushioned our economy in 2008. Today they’re dragging us right down with them. Finding an escape route that doesn’t involve China isn’t an option. We’ll get to why that is in a moment. But let’s stick with the GFC for now.

A repeat of 2008 is much closer than you think. David Dredge, a hedge fund manager at Fortress Investment Group, believes we’re on the cusp of another major downturn. Last week, he made what you might term a ‘big call’. Here’s what he had to say of the stock market volatility at the time:

August 2015 will go down in the record books, much like July 2007 or July 1997, as the beginning of the coming contractionary cycle’.

That’s not the worst of it either. Dredge sees this correction lasting anywhere between 18 months and three years.

Not everyone, though, shares this pessimism.

Saul Eslake, one of Australia’s most well-known economists, is one such voice. From the Sydney Morning Herald:

I don’t believe the turbulence we’ve seen in the equities markets in the past couple of months — initiated by events in China — is the beginning of another significant global crisis.

I don’t think there has been the sort of signs of a more generalised flight to quality or panic associated with financial markets. If anything — and it’s not a close parallel — it’s more like the tech wreck of 2000’.

Whose word should we believe then? If you’re anything like me, you’re leaning towards Mr Dredge. Why?

Well, two things stand out immediately.

For one, the world is a lot different to what it was back in 2008. China, which was growing at over 10%, hasn’t seen that kind of growth for years. Reaching 7% annual growth is hard enough as it is.

The other point is that Australia weathered the 2008 GFC without a hitch. We managed this on the back of the commodity boom. At its peak, the boom singlehandedly raised national prosperity. We can thank China’s rampant growth for this, too.

But those days are well and truly behind us.

China’s stock market crash was the first alarm bell for most people. Anyone that cared to look would’ve seen the signs as early as last year.

Now Chinese stocks are, without a doubt, overvalued. But high P/E ratios weren’t spurring the selloffs on their own.

Some may argue that Chinese markets have little bearing on the wider economy. But that ignores the psychology of the Chinese people.

We can’t divorce stock market volatility from the broader economy. People watch the market panic, and rightly worry about what it means for them. We can’t dismiss the market crash on consumer sentiment so easily. After all, why would the government prop up stocks like there’s no tomorrow? It’s because people might start to feel that there really is no tomorrow.

What they’re seeing now is disturbing. Stock market corrections, weaker trade, currency devaluations — you name it. The list of problems is as long as it is worrying.

Right now, China stands as the biggest threat to the global economy. As long as that’s the case, we can’t rule out another financial crisis.

And it matters even more in Australia’s case. The fortune of China’s economy drives our prosperity as well.

Even if there’s no GFC, there’ll be an ‘AFC’

No one would argue today that China’s economy isn’t slowing. Fewer still would say that it has no bearing on other economies. China’s slump might be a noose hanging around the global economy. But it’s a guillotine as far as the Aussie economy is concerned.

For arguments sake, let’s say that Saul Eslake is right. Let’s assume for a moment the global economy avoids another GFC. Would Australia breeze through it like in 2008? Not likely. Even if there’s no ‘GFC’, we may still witness an Australian Financial Crisis.

Trust is we can’t help but undergo our own financial crisis. You don’t need to be an economist to see why, either. For all intents and purposes, we’re wedded to China. Our saviour during the 2008 GFC now burdens us.

Is it any coincidence that Aussie GDP growth slumped to 0.2% in Q2?

Chinese demand for steel is falling, dragging on iron ore exports. We know this because inventories are rising, and construction is slowing.

China’s slowdown then presents real challenges for all commodity driven economies. Last week Canada became the latest commodity nation to enter recession. That bodes very poorly for our own economic outlook.

Like Canada, Australia’s trade terms are declining. The current account deficit fell by $19 billion in Q2. The value of imports exceeded exports by a hefty margin.

Meanwhile, Aussie business investment levels are tanking. Capital expenditure fell 4% in Q2, down 10.5% on last year.

Granted, non-mining investments expanded slightly. But it was nowhere near enough to offset falling mining investments.

Perhaps this shouldn’t come as such a surprise though. Household incomes and business profits are barely growing. Small wonder then that businesses aren’t investing.

That leaves us hoping for a commodity rebound; one that’s not coming.

Goldman Sachs predicts iron ore prices remaining at present levels until 2019. It notes that prices could bottom out at US$40 a tonne. That’s a hefty drop from the heady days of US$180 iron ore prices.

For what it’s worth, I don’t believe Australia will be alone here. Contrary to what Eslake says, the sequel to the GFC is coming. It could be bigger than anyone imagines, and not in a good way…

Tightening monetary policy to weigh on global growth

The global economy is bogged down by inconsistency. From interest rates to currency pegs, there’s a major imbalance.

On the one hand, you have developed economies with capital deficits. At the other end, emerging markets operate with capital surpluses. Here’s Dredge on this relationship:

‘[Emerging economies] have all tied their currency to the main protagonist on the deficit side, the US. [Global] monetary policy is determined by the deficit of capital side and flows through the currency linkage. You end up having some form or another of the same monetary policy on both sides’.

For a decade, this resulted capital influxes in emerging economies. And it works, up to a point. Once developed economies start reigning in credit, its game over.

The US will begin raising rates at some point in 2016. Once this happens, emerging economies will experience a crunch.

We already see this in motion. Foreign exchange reserves have fallen from peak levels. China’s forex topped out at $5.7 trillion in 2014. It’s since come down to about $5.19 trillion.

As capital flight picks up, emerging economies will find growth harder to come by. Global growth rates will collapse too. Problem is, the developed world isn’t growing fast enough to offset this. That will only raise the prospects for a second GFC in eight years.

For Australia, that’s a moot point. Even in a best case scenario for the world means little for us. We’re not equipped to escape the trap we dodged in 2008. Where are we now?

The economy is now just one quarter away from entering recession. Growth would have to fall below 0.2% in Q3. But even at this stage, we can’t rule that out.

One way or another, Australia is set for a challenging second half to 2015. According to Markets and Money’s Greg Canavan, a recession is all but guaranteed. Greg is one of Australia’s leading investment analysts. He warns that we’re sleepwalking into our first recession in 23 years.

In a free report, ‘Australian Recession 2015: Unavoidable’, Greg reveals why we find ourselves in this position.

Growing trade imbalances are already taking their toll on the economy. Government revenues are down, and household debt is up. Meanwhile, business spending is falling, as the outlook worsens.

But there is a silver lining in all this. There are actions you can take now to lessen the blows of the coming recession.

Download your free copy today to learn how to protect your wealth from the coming crash. To find out how to download his free report right now, click here.

Mat Spasic,

Contributor, Markets and Money

Markets and Money offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, Markets and Money delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors.

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