Thursday 07 Oct 2021 | 10:01 | SYDNEY
Thursday 07 Oct 2021 | 10:01 | SYDNEY

What does the financial crisis mean for Australia?

19 September 2008 17:01

Guest blogger: Peter McCawley is a Visiting Fellow at the Indonesia Project, ANU, and former Dean of the ADB Institute, Tokyo.

The rollercoaster ride on international financial markets has been extraordinary during the past week. As the week ends, both the players and the umpires (the regulators) are thrashing around trying to restore some order. How serious is the situation? Answer: very. Paul Krugman in the New York Times says 'the unthinkable has become the inevitable'. And US columnist David Brooks calls the situation 'a paradigm shift'. He says the crisis 'marks the end of the era of wide-open global capitalism'. Hundreds of other financial commentators agree that the situation is remarkable.

Will US authorities be able to restore order to chaotic markets? Probably, because they can still draw on huge resources in the US economic system. But the process promises to be nerve-wracking.

So what are the implications for Australia? Treasurer Wayne Swan and Reserve Bank Governor Glenn Stevens have been saying in recent days that the Australian economy will be able to weather the international economic storm. This is probably true. So far as we know, the Australian financial system is in much better shape than US financial institutions and the strong resource boom is still underpinning economic growth in Australia.

But the Australian economy surely won't escape unscathed. Growth across the international economy is now slowing sharply. Australian exports will probably slow into 2009, not least because international commodity prices are likely to fall. And turmoil in international financial markets will impact markedly on Australian financial markets both because capital flows might turn flighty and because confidence in Australian markets is strongly influenced by international conditions.

An economic storm in the northern hemisphere is bound to change the political mood in Australia as well. Support for the Whitlam Labor Government plummeted like a stone in 1974 when the international economic mood turned ugly. Kevin Rudd and Wayne Swan might find it useful to talk to former Labor Treasurers Bill Hayden and John Kerin. Both Hayden and Kerin found the experience of being a Labor Treasurer in the middle of a recession less than pleasant.

As for America, US authorities must now make very fast progress (days, not months) in tackling two huge but closely related problems. In the short term, there has been a remarkable collapse of confidence in financial markets in the US.  Financial systems stop working when confidence evaporates. Somehow, the authorities need to restore some confidence. The brilliant economist Maynard Keynes discussed the key role of confidence in markets in his famous book, 'The General Theory of Employment, Interest and Money'.  Chapter 12 on 'The State of Long-term Expectation', which is highly readable, is still one of the best things to read on the topic.

The longer-term structural problem, which US authorities must also tackle quickly, is that the US financial system is now seen to be loaded with 'toxic debt'. Somebody is going to have to take on the burden of this debt. And it increasingly looks as if the US taxpayer will foot a lot of the bill.

Photo by Flickr user Coneee, used undera Creative Commons license.