Bum and bummer; sub-prime doesn't pay

Overall, commentators have concluded on the basis of Mr Bernanke’s speech "More US rate cuts to come".

In Australia, economic activity continued strong in the December quarter. Retail sales and job vacancies both grew strongly - too strongly to be sustainable - in the year to November. Business investment remains strong and exports of resources have finally risen in volume terms, adding another layer of potential prosperity (on the top of sharp export price increases) to Australia’s boom.

China, India and other emerging economic powers seem likely to continue their dramatic growth even if the US economy slows substantially or even enters recession. With continuing strong demand for Australia’s resources, domestic inflationary pressures are likely to increase. As Treasurer Wayne Swan has said, he has inherited a lot of inflationary pressure from his predecessor. Interest rates are already rising both from policy hikes and as a result of sub-prime “ripples”. More rate hikes are virtually certain.

It seems that important Australian companies have so far avoided major problems. A property company, Centro, is having trouble refinancing a large slab of debt and the four major banks are reported to have a billion dollars of exposure to a US company that seems in even bigger trouble. To the extent our banks finance loans in global wholesale markets they cannot avoid the more subtle influence of rising global rates of interest.

Of course, continued worsening of the US crisis, more sub-prime “ripples” here and the expectation of further increases in domestic interest rates are likely to damage household and business confidence. The first signs of this are in fact to be seen with the latest Morgan survey of consumer confidence, released yesterday.

The Australian economy is likely to be favourably “dislocated” from the US crisis, as we were from the Asian crisis in 1998. Our inherent strength will carry us through unless there is some major shock, such as failure of a major US bank or $US150 (per barrel) oil following a geopolitical accident of some sort.

Clearly, however, the world economy is more vulnerable to such a shock than it has been for some time. The right approach for Australians is to tighten our belts, reduce borrowings whenever possible and increase personal and business productivity.

More on Ben Bernanke’s speech here.