Welcome to Finance and Fury. Are we in for another recession that we had to have?

With Governments increasing interest rates to combat inflation, are we on schedule to repeat 1990s

This term dates back to November of 1990 under which Paul Keating made a remark in response to monetary policy enacted

  1. This statement is slightly less famous than Keating’s prediction that Australia would become a “banana republic”
  2. But the recession of the 1990s saw a period of economic downturn affect much of the world in the late 1980s and early 1990s. The economy of Australia suffered its worst recession since the Great Depression – are we in for history repeating itself?

It helps to look at what created the situation of the 1990s along with the government and monetary responses

  1. The early 1990s recession describes the period of economic downturn affecting much of the Western world 
  2. Some of the primary factors that contributed to the recession include
    1. restrictive monetary policy enacted by central banks, primarily in response to inflation concerns – Central banks started to increase interest rates in response to concerns about inflation and decided to go on an aggressive rate hike policy –
      1. Interest rates in the early 1970s were around 6-7% on average – increasing to 10% from 1975 to 1980 – these levels of interest rates were not much of a concern back in this time period as when compared to today
      2. Household Debt to GDP was around 30% – in other words, the economy could afford to take on additional costs in interest rates when compared to today when Household debt to GDP is sitting at 120%, or 4 times higher when compared to the economic output of Australia
  • From 1980 to 1990 interest rates were high – increasing and reaching their peak in the late 80s to early 90s at around 17% on average until the early 1990s
  1. When interest rates were peaking – there was a loss of consumer and business confidence as a result of the 1990 oil price shock
    1. This price shock occurred in response to the Iraqi invasion of Kuwaiton August 2, 1990 – their second invasion of a fellow OPEC member – this lasted only nine months, the price spike was less extreme and of shorter duration than the previous oil crises of 1973–1974 and 1979–1980 – but the spike still contributed to the recession due to the fragile state of the economy – that was not equip to meet an increase in the price of oil from $17 per barrel in July to $36 per barrel in October of 1990 – today this is sitting at around $90 between WTI and Brent Crude
  2. What is also attributed but probably has less of an effect is the end of the Cold War and the subsequent decrease in defence spending – so government GDP looked lower due to the lowering government spending on defence reducing the G component of GDP growth
    1. Remember that GDP is made up of consumer spending, private investment, government expenditure and net exports
  3. The last cause is attributed to a loan crisis and a slump in office construction resulting from overbuilding during the 1980s – this deserves its own episode
  1. These are all contributing factors, but what initially sparked the recession is blamed on the October 1987 share market collapse – when share markets crashed around the world
    1. This crisis originated when Japan and West Germany pushed up interest rates, pressuring US rates also to rise, triggering a massive sell off of US shares – the average Global share prices fell an average of 25%, but Australia saw a 40% decline – as a result, 17 of the 18 major OECD economies experienced a recession in the early 1990s

Where did Australia sit politically – i.e. who was in charge of policy decisions –

  1. In Australia, the Australian Labor Party Government of Bob Hawke came to power in 1983
    1. At the time, Australia’s economy is not what it is today – as context – In the 1980s, Singapore Prime Minister Lee Kuan Yew predicted that Australia was at risk of becoming the “white trash of Asia” due to high unemployment, inflationary pressures and government debt. At the time of the comments, Bob Hawke was Australia’s Prime Minister and he stated that the comment was “not an overstatement”.
      1. In some respects, I would agree – Going back to Paulk Keatings remarks about Australia being a Banana Republic, he stated it’s the old cargo cult mentality of Australia that she’ll be right. This is the lucky country, we can dig up another mound of rock and someone will buy it from us, or we can sell a bit of wheat and bit of wool and we will just sort of muddle through … In the 1970s … we became a third world economy selling raw materials and food and we let the sophisticated industrial side fall apart … If in the final analysis Australia is so undisciplined, so disinterested in its salvation and its economic well being, that it doesn’t deal with these fundamental problems … … Then you are gone. You are a banana republic.
      2. What is missed in this statement is the difference between a banana republic which simply exports the raw goods, versus an industrialised country which exports the final good – take our natural resources as an example – Why do we import steel from China, why does 30% to 40% of our final lumber supply from Russia and Ukraine or why do we import 80% of our oil from refineries in Singapore, Malaysia, South Korea and China?
  • Is Australia still banana republic for the physical goods that matter as inputs to the everyday economic output
  1. This point aside – what happened in Australia in the 1980s – Ian Macfarlane, Governor of the Reserve Bank from 1996 to 2006, has said that the financial excesses of the 1980s were of such a scale that they made the 1990s recession “inevitable”, describing Australia’s economy at the end of the 1980s as overstretched and vulnerable to contractionary shock. The pressure of high interest rates on businesses – many of which were “borrowed up to the hilt” – became relentless.
    1. Some points of this are true – But the major factor that differs from then to today is the business borrowings around the incentives to lend from major banks – as now the CAR requires 100% of the RWA for a business compared to 35% for a collateral backed loan, such as a home, the lending composition has changed dramatically – Plus, corporate gross profits have increased from around $16bn in 1990 to $150bn in 2022 – so the level of debt increases after interest and principal repayments of debts, with the increases in interest rate rises, this might have slightly impacted corporate net earnings in the form of profits, but even after inflation, these are still massively up over this time period
    2. The way out of large levels of debt and government deficits is to allow additional economic activity to flourish – but policy doesn’t create a business-friendly environment
  2. Going back to the 1990s – The debate as to the causes or extent to which international factors and domestic government policy contributed to the severity of the recession continues to this day –
    1. Speaking in 2006, former Reserve bank Governor Ian Macfarlane said: The emphasis on interest rates and deregulation at least reminds us that what we are dealing with is essentially a financial event. The recession of 1990-91 was dominated by financial failures – “it was the fall in asset prices that meant that loans could not be repaid, thus transferring the distress to financial institutions”
    2. In essence – when the share market collapsed in 1987 – what followed was the political response – which dragged out the woes of the economy at large
  3. Commodity prices dropped and the Australian dollar sharply declined. The Reserve Bank conducted a $2 billion intervention to hold the dollar at 68c but it crashed to 51c. In December 1987, Keating said that the Australian economy would weather the storm because the Hawke Government had already balanced its Budget and brought down inflation.
    1. A surge in commodity prices began in 1986 and assisted the economy to a small 1987 surplus of $2.3 Billion. With commodity prices now over their peak, economic conditions were entering a decline, with high interest rates, a growing current account deficit, declining demand, increasing foreign debt and a wave of corporate collapses. Furthermore, the collapse of the Eastern Bloc economies, was to see wool and wheat prices decline, savaging Australia’s agricultural sector.
  4. Going back to the recession we had to have – Treasurer Paul Keating budgeted a record $9.1 billion surplus for 1989–90, and Labor won the 1990 election
    1. This was aided by the support of the greens and environmentalists – To court the green vote, environment minister Graham Richardson had placed restrictions on mining – between iron ore, but mostly on uranium mining but also logging which had a detrimental effect on already rising unemployment – cutting job opportunities when unemployment is already high tends to lead to higher levels of unemployment
  5. By July 1990, Australia had entered severe recession – But Paul Keating initially insisted that Australia would face a “soft landing” – where there would be little to no effects from their economic policies – this was a similar economic sentiment as to what we have been told over the last year –
    1. however, by September 1990 there was a large contraction in GDP – so Keating adopted a different political strategy which is where the population started to be told that this downturn was a necessary correction – so rather than a soft-landing scenario we went to a recession that we needed to have
  6. The recession started in the September quarter of 1990 and lasted until the September quarter of 1991. During the recession, GDP fell by 1.7 per cent, employment by 3.4 per cent and the unemployment rate rose to 10.8 per cent. Like all recessions, it was a period of disruption and economic distress.
    1. The peak of the fallout – A number of financial institutions failed around Australia, including the State Bank of Victoria, the State Bank of South Australia, the Teachers Credit Union of Western Australia, the Pyramid Building Society as well as several merchant banks, a mortgage trust – Many of these had ties to state economies – such as the State Bank of South Australia, owned by the Government of South Australia, which collapsed in 1991. The bank had been a beneficiary of the commercial property boom of the 1980s, but by February 1991 the Bannon Labor Government had to launch a $970 million bailout due to its bad debts, and the bank’s debts soon reached $3 billion.
  7. GDP sank, unemployment rose, revenue collapsed and welfare payments surged.
    1. the former Reserve Bank Governor Ian Macfarlane stated that policymakers did not “set out to have a recession in order to reduce inflation. The recession happened because of the unwinding of the excesses of the 1980s”. High interest rates were employed to slow the asset price boom of 1988–89.
    2. Treasurer Keating, the Reserve Bank and Treasury itself generally agreed on the need for high interest rates in 1989 and the pace of their reduction.
  8. Government promised economic recovery for 1991 and launched a series of asset sales to increase revenue.
    1. During this time period Privatisation – with the sale of Government asserts like CBA and TLS – began a private sale to population for CBA in 1991 – plus the first round of sale of Telstra in the 1990s with the second round earmarked for November 1998
    2. Reforms were conducted between 1990 and 1991, with Australia’s telecommunications opened to competition; and tariffs were reduced to five per cent, while the phasing out of textile, clothing and motor vehicle protection began.
    3. A slow recovery from recession began around the September quarter in 1991, though unemployment continued to rise until late 1992
      1. Following the early 1990s recession, Australia experienced a record period of economic growth.

Where do we stand – At the moment – From the RBA – GDP is forecast to grow by 3¼ per cent over 2022, 1¾ per cent over 2023 and 1¾ per cent over 2024. These forecasts are lower than three months ago. Strong demand for labour is expected to see the unemployment rate decline to 3¼ per cent in late 2022, lower than the previous forecast

  1. Compared to the early 90s – Some economic conditions are the same, some are not
    1. Not as reliant on exports – have a larger serviced based economy than in the late 80s and early 90s
    2. In regards to interest rates and debt levels – debt is higher, less in business and more in consumer
      1. Interest rates aren’t expected to reach anywhere near their levels of the early 90s – but the impact of a 1% increase in rates is much greater than the 90s – also the debts being mostly in consumer debts, i.e. mortgages – For banks, this is better as there is collateral to recoup loans compared to overleveraged businesses
    3. Bank collapses are less likely – for better or worse, the TBTF legislations and the consolidation into a handful of financial institutions reduces the chance of bank collapses significantly – this created peak economic fallout, so this should be avoided
  2. At the moment – the RBA forecasts for GDP is lower than expected – but growth is still positive – Australia may avoid the recession – especially if government spending doesn’t decline – and consumer spending stays the same
  3. Also not had a crash in the market on the scale of 1987 in a short period of time

Doesn’t mean that other countries are out of the woods – the UK and countries in the EU aren’t looking so good, the US as well – so if their markets tank, Australia may follow suit

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