Bad feelings become self fulfilling

In Australia, the anecdotal evidence is that banks are not recalling active loans, unless there are problems with repayments, but they are proving reluctant to make new loans or extend existing credit lines.

They may also prove more difficult about renewing loans, when businesses have to renegotiate credit lines which they usually do every three years. I recently saw an announcement for one developer that a major building project in Brisbane would not go ahead, due to finance. The money was still available, but with all sorts of conditions imposed by the bank involved - conditions which the developer thought it could not meet.

Incidents like that may be happening all over the developed world.

This reduction in business activity is revealing weaknesses that would have remained hidden for years - and is revealing them all at once. Recent efforts to restore liquidity to the banking system are, incidentally, aimed just as much at banks as at consumers. The idea is to get banks lending again.

In the meantime the markets have reacted to the looming recession with a blood bath which, in typical market fashion, may have gone too far. One underlying indicator of the value of Australian stocks are price earnings ratios. The average P/E ratio for the market at the height of the stock market boom late last year was 25 - that is, companies would take 25 years to return profits equivalent to its market price. That was probably too much. Typically something like 12 would be regarded as solid value and 18 would be over sold - depending on expected economic conditions. The market prices in expected reductions in profits, well before they happen and profits are expected to take a hit this year. Following a pick up in prices earlier this week, the average P/E ratio for Australian stocks was around 11.4.

At this stage anyone who tells you they know what is going to happen next is probably trying to sell you something. My guess (I emphasise the term “guess”) is that as our banking system does not seem to have been badly affected - our regulatory authorities may take a quick bow - the recession will not be very deep or long in Australia.

The sharp falls in resource prices is more of a worry for our long term future, but Australia was always much more than resources and the economy has been booming for some time. A period of consolidation may even help, although that will be small consolation for those who lose their jobs over what amounts to a crisis of confidence all brought on by a boom and bust in American house prices.