Could Australia survive another financial crisis?

Professor Nouriel Roubini. Image credit: Rebecca Le May/AAP

It’s rare that doomsayers can be useful but a recent article by prominent Hanrahan School economist Nouriel Roubini is worthwhile. Roubini offers 10 (count ’em) mainly Trump-related reasons why there will be another financial crisis and global recession in 2020.

The Reserve Bank is more optimistic. In its Financial Stability Review released last week, it referred to growing downside risks around the world — Trump’s protectionism and high asset values, in particular — but it is more relaxed.

The tightening in the United States and divergent monetary policies have not disrupted financial markets as central banks have been careful to clearly communicate their expected paths for policy. Overall, positive economic and stable financial market conditions have supported financial stability. However, the extended period of low interest rates has seen some financial stability risks emerge. Notably compensation for risk is very low with asset prices in a range of markets at high levels, underpinned by low long-term interest rates. Household, corporate and sovereign debt has also risen to high levels in some jurisdictions. For emerging market economies – especially those with structural or cyclical vulnerabilities – there are concerns about the implications of a tightening in financial conditions in the advanced economies.

Nonetheless, the RBA’s acknowledgement of greater risk is an opportune moment to reflect on how well placed Australian policymakers are to respond if external factors like the idiocy of the US political system inflict an unexpected slowdown on the economy.

Despite the claims of the “punitive rate rise now!” crowd at The Australian Financial Review, the RBA has plenty of scope both to cut interest rates and, if necessary, embrace less orthodox means of monetary policy stimulus, even if it says that chances are the next rate rise will be up, as it did in yesterday’s minutes of its October meeting:

Taking account of the available information, members assessed that the current stance of monetary policy would continue to support economic growth and allow for further progress to be made in reducing the unemployment rate and returning inflation towards the midpoint of the target. In these circumstances, members continued to agree that the next move in the cash rate was more likely to be an increase than a decrease.

But the story is now less clear on fiscal policy. The government has been far better at fiscal discipline since 2015, and it has benefited from persistently stronger commodity prices. But an early return to surplus is now competing with a kind of late-Howard period effort to buy an unlikely election victory. Various policy fires are being hosed down with cash — the Catholics got a handout, small business is getting a handout, the West Australians got a windfall, now the eastern states are being guaranteed money because of the WA windfall.  The result will be a slower return to a smaller surplus and thus less fiscal firepower to deploy in the event of a crisis.

There are other policy complications as well. As the RBA noted in its stability review, while Australia’s banks are stronger than a decade ago, the banking royal commission has shown that banking culture is problematic. “International experience has shown that poor culture can have significant adverse effects on banks, including on their financial performance and capital position,” it warns.

“Likely changes to the financial services industry should help both restore trust and reduce the risk of future misconduct. It is important that the response to these findings balances the need for banks to be able to efficiently recover bad debts with the need to protect consumers from inappropriate conduct.”

Clearly the RBA will be watching the response to Kenneth Hayne’s final report. But there’s another issue for the RBA to consider. Just as RBA governor Philip Lowe acknowledged earlier this year that wage stagnation undermined voter support for economic reform, it’s likely that years of being ripped off by our major banks will significantly undermine support for any emergency assistance for banks in the event of a financial crisis. How would voters respond to billions of taxpayer dollars being committed to prop up the banks that have been gouging them for so long? At least some of the destructive populism of recent years is the result of the perception the people who caused the financial crisis got bailed out, not jailed, after 2008.

Roubini and co are almost certainly wrong — but it pays to take heed of what might happen in the world they predict.