Crisis contagion and Australia

What is the most effective way of dealing with the impact of the world economic crisis?

The crisis began with US financial institutions lending trillions of dollars mainly on the security of houses to millions of persons incapable of maintaining repayments. They then on-sold packages of these near-worthless securities to financial institutions throughout the world. This revealed a previously unsuspected gargantuan level of irresponsibility and greed among very many of the largest corporations in modern capitalism.

Governments must now rethink their attitude to market regulation in the way that Keynes in the 1930’s forced a rethink of economic theory to overcome the Depression. Because of the size and power of many corporations the interaction between entrepreneurial greed and poorly regulated markets is now a critical problem affecting the entire international economy. But it also perilously affects the planet’s environment and human health. The case has become overwhelming for ensuring that markets serve rather than shape society.

The financial corporations’ behaviour has infected every modern economy both through the involvement of their financial institutions and through the subsequent decline in global trade.

While Australian banks have been affected less than British and European financial institutions nevertheless they have lost several billion dollars through exposure to “sub-prime” securities. Despite this a recent Sydney Morning Herald investigation showed the banks recent credit offers to those seeking home mortgages was approaching the irresponsibility of US banks.

Kevin Rudd’s recent, thoughtful, article in The Monthly was strongly critical of the market’s role in modern capitalism. Yet there is a disconnect between this criticism and his Government’s response to the current crisis. He has said that Australian banks are well regulated; but this only covers APRA’s prudential requirements. Since the Hawke-Keating government’s deregulation of the financial system in the 1980’s there have been no controls over the quantity and direction of bank lending. Since World War 11 until that time the Reserve Bank held a proportion of the banks’ deposits (called the Statutory Reserve Deposits) which could be raised or lowered according to the Reserve Bank’s assessment of the level of aggregate demand relative to productive capacity. Raising the SRD would restrict the banks capacity - and tendency - to increase lending in times of excess demand and inflationary pressures.

As recently as last year the banks pressured millions of Australians to increase their credit limits at the very time that this added to inflationary pressures. This then induced the Reserve Bank to raise interest rates so as to lower the very demand the private banks were generating. Lowering the SRD would expand the banks capacity to lend in times of declining demand when unemployment was rising.

As a further control the pre-deregulation Reserve Bank could require the banks to increase or reduce their lending to particular sectors or regions of the economy according to both the demand/capacity relationship and government priorities. In this way the housing or export industries, for example, could be protected from a reduction in lending.

In summary a deregulated market can encourage increased credit when credit reduction is desirable which then induces the Reserve Bank to raise interest rates; and it can discourage credit when credit expansion is appropriate and therefore help to raise unemployment.

To help arrest the economic decline the government, in a somewhat demeaning stance, has pleaded with the banks to lend to credit worthy customers. If the government had retained the Commonwealth Bank, sold off in two tranches by both the Keating and Howard governments, this would not be necessary. There is now no mechanism for ensuring (rather than encouraging through reduced interest rates) an expansion in bank credit. An Australian Government bank should be an essential addition to the government’s economic armoury to provide funding for projects where short-term profit/risk considerations block funding from private banks.

The bank could also be used to provide long-term funding beyond normal commercial considerations to the struggling farm sector. The bank could be run by an independent Board with a charter to give priority to the long-term national interest rather than short-term profit. Such a bank could readily be financed from the Australian Government’s Futures Fund or from a small part of the stimulus package.

A major portion of the economic stimulus package - the two tranches amounting to $22 billion of cash handouts - has had, and will have, little impact on employment compared to direct government spending on public facilities and services - leaving aside the handouts’ minimal contribution to society’s welfare or productive assets. A significant part has been, and will be, saved and another large portion has been, and will be, spent on imports.