The world economy through a crystal ball

The world hasn’t experienced a simultaneous downturn in its two largest economies since the mid-1970s. Even though prospects for Japan and (according to some) Germany are looking brighter now than they have done for some years, they aren’t large enough nor likely to be strong enough to offset the effect of simultaneous downturns in the US and China towards the end of this decade.

Nor can it be safely assumed that Australia will be able to slough off a global downturn in 2008 or 2009 as it did the Asian crisis of 1997-98 or the post-“tech wreck” global slowdown of 2001.

On each of those occasions, at least one of our major trading partners was booming - the US (and to a lesser extent) the EU in 1997-98, and China (which by then was already our fourth largest export market) in 2001. If the US and China experience simultaneous downturns in 2008-09, the stimulus (equivalent to more than one percentage point of GDP per annum) that we are currently enjoying from our rising terms of trade will go swiftly into reverse.

Nor can it be assumed that we can stave off a downturn by slashing interest rates, as the Reserve Bank did in 1997-98 and again in 2001. The Reserve Bank may well, and properly, cut interest rates in the event of a simultaneous downturn in the US and China in 2008-09. But, now that Australians have begun to (re-)learn that house prices can’t be relied upon to keep rising indefinitely, it is difficult to believe that this will spark a renewed upsurge in household borrowing and spending in the way that it did on those two earlier occasions.

Instead, and subject to any difficulties that we too may have in financing our own current account deficit, if and when, China turns off the money-tap, the only solution will be to open the fiscal floodgates with some combination of tax cuts and increased public spending. That would be the appropriate time for disbursing the revenues that are currently flooding into Canberra - rather than, as seems more likely, before the next election (due in 2007).

So a prudent five-year forecast should allow for the possibility that what may well extend into an 18 or 19-year streak of continuous growth in the Australian economy could come to an end some time during that period.

File this away for five years and - who knows? I’m unlikely to be in the south of France (dangerous place, these days); or I might be preparing another five-year forecast.