A short, sharp recession due, but we're a safer bet

Is recession coming? Yes for the US; no for Australia, with rate cuts to come.

The US votes tonight in the shadow of recession. Consumer confidence is at record lows, equity prices are low and house prices are still plunging.

The "China effect" was meant to insulate Australia from major effects. But now the US is thought to be leading Euroland and Japan into recession and China has slowed appreciably.

Commodity prices are down by about 40 per cent, eliminating the bubble effect, perhaps showing some "undershooting" as markets adjust in the opposite direction.

Australian equity prices have fallen by about the same amount in percentage terms as Wall Street, Australian house prices are falling and consumer confidence is falling.

The graph on page 26 compares US and Australian consumer confidence. The data has been compiled since 1973 for Australia by Roy Morgan Research and by the Conference Board since 1977 for US consumers.

The US measure clearly picked the three US recessions - in the early 1980s, the early 1990s and 2001. The current reading is a record low, suggesting this recession will be severe.

The Australian data shares the gloom of the early 1980s and early 1990s, but conspicuously failed to dip in 2001. Now it is down but not (so far at least) to the depths reached in the earlier recessions.

There is one, more speculative, point to be made in comparing the two series. US consumer confidence appears to be more volatile than Australian consumer confidence. Except for the mini-boom of the mid-1980s, the lows of US confidence were lower and the highs were higher.

Does this perhaps reflect the more flexible, volatile nature of a freer, more innovative US economy?

Many influential people are saying the US is in recession now. This is effectively confirmed by the early estimation of US GDP, which suggests negative growth in the September quarter.

Will the US recession be deep or will it be long? Or could it be both deep and long?

My money is on the US recession being sharp but short. The win by Barack Obama, predicted by all the polls, would bring to the stage a new president with a message of hope and necessary change.

US monetary policy has been eased and fiscal policy is adding further stimulus. American resilience and entrepreneurial flair will do the rest.

Australian monetary and fiscal policy have already been eased. The easing is pre-emptive, in marked contrast to previous post-war experience.

In both the recessions of 1981-82 and 1990-91 fiscal policy and monetary policy were eased only when it was blindingly obvious that the economy was in trouble. In the mini-boom of the mid-80s, fiscal and monetary policy were tightened pre-emptively and this prevented - or at least delayed - the usual boom and bust scenario.

Monetary policy has notoriously been moved too little, too late, meaning cash rates have risen too slowly in booms and thus eventually have had to rise more than might have otherwise been necessary.

Cash rates have also been required to remain high for enough time to ensure the "recessions we have had to have" were sufficient to reduce inflation.

In the long China boom, Australian cash rates were again raised too slowly and as a result eventually went higher than they needed to.

But the subsequent easing this time was far more timely and there already has been a 125 basis point cuts from the high point of 7.25 per cent.

Today is that one day in the year when the nation stops for a horse race. In Henry's day that meant the board meeting was suspended and members and advisers adjourned to the dining room where a television set was provided so the race could be followed.

Nowadays, with an announcement of the board's decision required by 2.30pm, the meeting must of necessity be far brisker, with papers taken as read and only the most telling questions asked and answered.

We have all been given a pretty good idea of the thinking of the management of the Reserve Bank. I refer to the fine recent paper by Deputy-Governor Ric Battellino.

"The daily barrage of gloom and doom" makes it easy to lose perspective, a situation that Battellino sets out to remedy.

Over the past five years, "the amount of money that Australian households had left over to spend, after paying taxes and interest on all their loans, grew in real terms at the fastest rate in over 30 years".

This was due to fast growth of wage and salary incomes (average 7.5 per cent per annum), fast growth of income from investments (17 per cent a year, apart from capital gains on shares), tax cuts and modest inflation.

Real disposable income grew at an astonishing 6.1 per cent annually. This growth greatly exceeded that of any other developed economy - US growth was half this, for example.

Furthermore, strong growth was evenly spread over the income levels. Growth was reasonably egalitarian.

Of necessity growth will be far slower for the next year or so, but then should pick up again. "Australia remains, after all, a very dynamic economy."

Battellino looks carefully at household balance sheets. Assets are far higher than liabilities.

Assets are largely in market-linked investments, mostly shares whose performance over the long term greatly exceeds that of fixed interest.

Battellino's conclusion is relatively cheery. "While nobody can predict accurately all that lies ahead, it is important not to become too pessimistic because, fundamentally, household finances and the economy more generally remain in good shape. The main problem that had built up - inflation - is manageable and is being dealt with."

In the body of the talk is the warning shot: "... there is still a big task ahead to bring inflation down and this could limit room for manoeuvre on monetary policy".

Holding at current levels would be a safer bet for the economy, but a riskier bet politically.

Henry's bet is that the Reserve Bank will cut the cash rate by another 50 basis points today.

Sources: Australian Consumer Confidence (1973-2008) - roymorgan.com; US Consumer Confidence (1977-2008) - The Conference Board - conference-board.org