The West's time in the economic sun may be over

Great news. On July 21, 2009, Access Economics announced it expects Australia’s economy to grow slightly during the current financial year as China’s early recovery will boost demand for Australia’s raw materials, while retail spending had been aided by the government’s stimulus package. The only drawback is that Australia’s unemployment rate will rise until late next year as business profits and spending fall away, and with interest rates also likely to increase in the longer term.

Days later, 57 respondents to a US survey in July predicted that growth will be 1.5 per cent in the July-to-December period, although the US jobless rate will exceed 10 per cent early next year (Sydney Morning Herald, July 24, 2009).

With the US federal government effectively putting up $23 trillion to back its economic system, an amount equivalent to more than 150 per cent of its GDP, greater confidence has indeed returned.

But hang on. What about all the pessimistic information we get from around the world, particularly from John Mauldin and Dan Denning (two financial experts)?

From July 12 to July 27, I learned that Chinese banks which were hiding as much as $500 billion in bad debts and had lent more than $1 trillion in the first six months of 2009, about four times the rate of 2007.

Debt levels of some Western nations are also becoming unsustainable. The IMF recently urged Britain to map a path back to solvency. By 2009, 12 OECD nations had gross government debt levels of more than 60 per cent of GDP with Japan highest at 173 per cent and rising. This does not include the loan guarantees and toxic asset purchases administered by the G20 nations, estimated by the IMF to be around a third of their combined GDPs, nor record household debt to disposable income ratios with US consumer debt alone rising from 12 to 18 per cent of GDP since 1982.

Declining revenue has already seen the US federal government produce a $US1 trillion budget deficit in just six months. California’s government recently agreed to a $26.3 billion budget deficit that includes $15.5 billion in spending cuts, while Ireland passed two emergency budgets to stop its deficit soaring to 15 per cent of GDP as unemployment reached 12 per cent.

And governments need to finance debt. The Hayman Company recently estimated that the US will need to issue $US3 trillion in 2009 to support government financing. The estimated global amount needed was $US5.3 trillion with Japan next on $US536 billion.

The truth is that the real US economy, central to a revival of the world economy, has serious problems ahead. For instance, California (the world’s 8th largest economy) lost another 65,000 jobs in June, while the number of Americans with no unemployment payments at all is predicted to reach 500,000 by the end of September.

There are still possible global ramifications from US debt should a recovery not occur. In addition to the sub-prime market disaster which involved $US1.5 trillion of debt, prime mortgage debt is near $US4.5 trillion, commercial real estate near $US3.5 trillion, and Alt-A mortgage loans more than $US2 trillion. Other sectors with debt levels of $US1.0-1.5 trillion are commercial and industrial, jumbo prime, home equity, credit card, and auto. Most problematic are Alt-A mortgages, which will have interest rates reset from 2010 to 2012, and jumbo prime loans (on average $750,000), because they occurred mostly in the inflated bubble states (such as California and Florida).

Sure, we must always live in hope, but when individuals like billionaire Warren Buffet expect inflation to rival rates in the 1970s (13.3 per cent in 1979), we need to pay greater attention to what is happening overseas.

So what are the solutions? Do we just crackdown on bank behaviour? With lending crucial to creating investment opportunities, many banks are presently reluctant to lend in such difficult economic times. With a tighter capital market, foreign banks have reduced their lending activities to Australia with syndicated loans falling by 80 per cent in the first six months of the year to $US9.7 billion, although global syndicated loans fell 49.2 per cent to $947 billion. (Syndicated loans refer to loans where one or two banks organise an overall loan package in which multiple foreign banks are lenders to reduce the risk to individual lenders).