Currencies

[Elroy Jetson]

Australian Reserve Bank warns of economic instability due to overseas credit creation

http://www.abc.net.au/worldtoday/content/2004/s1073698.htm

The World Today - Thursday, 25 March , 2004 12:26:00
Reporter: Stephen Long

HAMISH ROBERTSON: Here at home the Reserve Bank has issued a new report today acknowledging potential risks to the Australian economy, from the homefront and abroad.

In its first publication on financial stability, the central bank says there is a mid-term risk that debt-laden households will cut back on spending, amplifying a future economic downturn.

It also says that easy money and cheap credit are encouraging overseas investors to pursue high yield, risky investments.

Well, just before we came on air I was joined in the studio by our Finance Correspondent Stephen Long and I put it to him that the report was a pretty sober assessment.

STEPHEN LONG: Well, yes, Hamish, but the warnings aren't up in headlights and overall the Reserve Bank is stressing that financial stability in Australia is looking pretty good and the economy is in good shape, as are the major banks.

That said, it is clearly concerned at the huge run up in household credit and debt outstanding, which has been growing at an annual rate of 15 per cent and an even faster 22 per cent over the year to January this year.

And with people borrowing so much to fund predominantly housing loans – that's 85 per cent of the debt – and more recently investment housing, which was been growing at 23 per cent a year, and then redrawing on their mortgages to fund their lifestyles, there is a risk that if people cut back on that spending, it could lead to an economic down turn.

Just look at these figures for instance: housing equity withdrawal as it's known – people drawing money out of their mortgages to fund consumption – that now accounts for 4-and-a-half per cent of disposable income.

So if there was, say, the housing market coming off the boil, people feeling less secure or if the economy started to turn down and people were less secure and losing jobs and they cut back on spending, in the jargon of the Reserve Bank, 'consolidated their balance sheets', the risk that the Reserve Bank acknowledges is that could amplify any economic downturn that was around.

HAMISH ROBERTSON: This assessment by the Reserve Bank does seem to have ominous parallels with the warnings contained in this week's edition of The Economist magazine that Australia is heading for a crash.

STEPHEN LONG: Indeed, indeed, the parallels are remarkable. However, whereas The Economist sees this as a strong risk, at this stage the Reserve Bank is saying it is only a small risk to the Australian economy.

HAMISH ROBERTSON: So the Reserve Bank is trying to put this with a sense of perspective?

STEPHEN LONG: Yes. Where they it's a small risk though, they do acknowledge that in a sense it is difficult to assess how strong the risk is because in the past we haven't had this situation, and generally when you've had an economic down turn being amplified, it's been amplified by corporates cutting back on spending or banks cutting back on lending.

So this peculiar situation of having such heavily indebted households and the risk that household spending is going to be cut back seriously and precipitate a very, very serious downturn, is a situation that is really almost unprecedented.

Whereas the Reserve Bank is saying the risks are small, it's on the other hand acknowledging that it's actually difficult to get a gauge on how serious those risks are.

HAMISH ROBERTSON: Australia's economy of course, is also very vulnerable to changes to the economies in other countries. What are the Reserve Bank's concerns about the overseas position?

STEPHEN LONG: Well, it's big concern is that cheap credit, with very, very low interest rates overseas, the lowest we've seen in 46 years in the US at just 1 per cent, and a flood of easy money that's been used to prop up economies after the tech wreck is actually encouraging investors into high yield risky investments, and also we've seen it fuelling a similar housing bubble in the United States.

HAMISH ROBERTSON: It's not alone in that thinking, is it Stephen, because many in the United States also share those fears?

STEPHEN LONG: Certainly, there are economists on the left and the right who are saying that. It's another key concern of The Economist magazine. Many liberal economists, many market economists in the United States fear that Alan Greenspan has actually precipitated a second bubble after presiding over the irrational exuberance of the tech boom, which brought the US economy undone, precipitating the largest crash in financial history.

The cheap credit in the US in particular, there are fears this had led to a second bubble, this time largely in the household sector, but also in these high yield, high investment areas that could really cause a serious problem overseas, precipitating a new global down turn, but I must say the Reserve Bank, as I said, isn't putting that risk in headlights and is acknowledging it as a potential risk – serious, significant, but at this stage small.

HAMISH ROBERTSON: I was speaking to our Finance Correspondent Stephen Long.