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Fed: Global recession engulfs once booming economy

By Colin Brinsden, Economics Correspondent
21 Apr 2009 4:54 PM

CANBERRA, April 21 AAP - The global recession - the consequence of many Americans being unable to pay their highly-complex home loans two years ago - has claimed another victim ... us.

Reserve Bank of Australia (RBA) governor Glenn Stevens confirmed most economists' suspicions on Tuesday that the Australian economy is already in recession, for the first time since the early 1990s.

"Whether or not the next GDP statistic, which is due in early June, shows a further contraction, I think a reasonable person looking at all the information that we have available now would come to the conclusion that Australia too is in recession," Mr Stevens told a lunch in Adelaide on Tuesday.

A recession is normally defined as two consecutive quarters of negative growth. The December quarter gross domestic product (GDP) figures released last month showed the economy shrank 0.5 per cent, the first decline in eight years.

When the crisis broke, an Australian recession seemed inconceivable.

There appeared no end in sight to a resources boom that was bringing in billions of dollars each year, while boosting the jobs market.

This would eventually take the unemployment rate to a 34-year low of just 3.9 per cent in February 2008.

One year later the jobless rate is 5.7 per cent and heading higher.

The economy was steaming along at an impressive annual pace above four per cent when the collapse of the US sub-prime market came to light in August 2007.

By the end of 2008, annual growth was a mere 0.3 per cent, and now appears destined to go even lower.

At the start of the crisis it appeared to be a localised problem in the US.

Engineered by financial boffins on Wall Street, sub-prime mortgages were doled out freely to Americans who would not normally make the grade for a home loan.

All was fine until interest rates in the US started to rise and sub-prime borrowers couldn't make their repayments.

Some would later argue that some of these borrowers shouldn't have been given a mortgage in the first place.

The complexity of these mortgages meant that any default had wider ramifications through an array of debt instruments - which were later to be called "toxic assets" - hitting major banks beyond the shores of the US.

But all of that was on the other side of the world.

Sure, the Australian stock market took a hefty dive from record levels with other global equity markets, but the economy didn't have the same exposure to sub-prime debt as other countries and it had extremely well regulated banks.

Indeed, former treasurer Peter Costello said in July 2007 that Australia's fundamentals were "very strong".

"I am sure that we can weather global instability but it is just putting a big unknown out there as far as economic management goes in the months ahead," Mr Costello said.

And this was a theme that would be carried on by the Rudd government when in came to power in November 2007 and well into its first term.

Australia would not be immune from the fallout of the global financial crisis, but it was in a better position to handle it.

So strong was the economy, it was inflation that was the problem and one that new Prime Minister Kevin Rudd, with help from the RBA, was determined to defeat.

The central bank was still raising interest rates up until March 2008, even as the global economy was getting gloomier.

Nomura Australia chief economist Stephen Roberts said in hindsight it was an "extraordinary anomaly" that they were still raising rates then.

"(But) nobody foresaw how big this thing would be," he said.

In May last year new Treasurer Wayne Swan delivered a budget aimed at curbing price pressures through spending cutbacks and amassing a whopping $21.7 billion surplus for 2008-09.

"(This is) a budget carefully designed to fight inflation, and ensure we meet the uncertainties of the future from a position of strength," Mr Swan said in his budget speech.

Still, economic growth did start to slow under the weight of 12-year high interest rates, high petrol prices and an overall increase in the cost of living which eventually saw inflation hit 5.0 per cent - well beyond the RBA's two to three per cent inflation target.

By the June quarter annual economic growth had dropped to 2.7 per cent.

Consumer confidence had slumped, resulting in weak retail spending.

Business confidence also tumbled, but investment was still strong because of the huge profits made from the commodities boom.

In the second half of 2008 the mood dramatically changed.

Economic growth in China eased into single figures as it too fell foul of the global downturn, and the seemingly endless resources boom was finally at risk.

In September the RBA cut its cash rate by 25 basis points citing still difficult international financial markets and heightened concerns over credit.

This was the central bank's first rate cut in seven years, and marked the start of a rapid easing in policy which saw a total 425 basis points cut from cash rate by April this year.

Days later Lehman Brothers, one of the world's biggest banks, collapsed and the US Federal Reserve wasn't prepared to prop it up.

"Letting Lehman go led to a question mark over central bank policy dealing with the financial crisis - who was too big to fail, who wasn't? Where do you draw the line?" Mr Roberts said.

"A great deal of uncertainty was opened up, and worries over credit took a lurch for the worse."

In October, despite Australia's big four banks being rated in the world's top 20 and barely exposed to "toxic assets" compared to other countries, the government was forced to guarantee their liabilities.

Other governments were protecting their bank deposits as the credit crisis deepened, which would have left Australia at a distinct disadvantage if the Rudd government hadn't followed suit.

Within days the government also announced its first stimulus package - the economic security strategy - as countries around the world began toppling into recession.

The $10.4 billion package would dole out $8.7 billion in cash handouts to pensioners, carers and low-income families just before Christmas.

The first home owners grant was also increased until mid-2009.

The government wanted the cash spent to stimulate the economy, and subsequent data did show a hefty 3.4 per cent increase retail activity in December.

However, it was also clear that concerns over job security meant that people were equally saving the money or paying off debt.

Even before the December quarter national accounts were released, the government announced its second stimulus package - the national building and jobs plan - worth a staggering $42 billion.

This included around $11 billion in one-off welfare payments to families, students and farmers, while taxpayers would also get a once only bonus of up to $900.

The budget bottom line by this stage was a huge $22.5 billion in deficit.

Even though half of the nation is still waiting for their bonus cheques, Mr Rudd was forced to concede on Monday that the economy will inevitably be dragged into recession.

On Tuesday, Mr Swan was sticking to the line that the economy was still the best positioned to weather the global crisis.

"It's also important ... we underline the strengths in the Australian economy because out of all of the developed economies in the world there is one that most people would want to be in and it still remains the Australian economy."

That may be, but we're still in recession.