Raise your hand if you remember “the recession we had to have”. You’re showing your age when you’ve done it.
As we approach this federal election, any winner should best remember these immortal words from former Prime Minister Paul Keating in November 1990, just as the economy was beginning to collapse.
The contraction then was nowhere near as severe as the COVID-inspired slump we are now emerging from. But the aftermath was much more severe and lasted much longer.
The other intriguing difference was that instead of an unpredictable pandemic out of our control and ravaging our lives, the last great recession was of our own making.
We didn’t have to have it at all.
And now the warning lights are flashing. Once again, we seem to have forgotten the lessons of history, and it’s entirely possible that Western economies are making many of the same policy mistakes that caused the great global downturn more than three decades ago.
The recession of the 1990s was engineered by central banks. After a decade of greed and excess – culminating in a financial crisis sparked by a stock market crash – central banks decided to stem runaway inflation with the only weapon at their disposal: interest rates.
They took them to ridiculous heights and kept them there. In the two years to January 1990, the Reserve Bank raised interest rates by 7 percentage points, to a peak of nearly 18 percent. Mortgages and business loans were significantly higher.
It had the desired effect; The resulting recession certainly killed inflation. But while the downturn was officially over by mid-1991, it took a decade for employment to recover, ruining the lives of millions.
Could it happen again?
Bill Dudley certainly thinks so.
Former New York Federal Reserve Chairman Dudley says the Fed has waited far too long to take action on inflation.
According to Dudley, if the Fed is to rein in runaway prices — which at 8 percent is a 40-year high — it must raise interest rates to a point that will trigger a stock market crisis and send unemployment skyrocketing.
“That means the Fed needs to do more to slow down the economy,” he told Bloomberg last week.
“The Fed has to tighten enough to push up the unemployment rate, and when the Fed has done that in the past, it has always resulted in a recession.
“That’s not their intention – they will aim for a soft landing – but their chances of making it are very, very slim.”
He seems to have correctly assessed the mood.
Right on cue, St. Louis Fed Chairman James Bullard said Friday that US interest rates could climb to 3.5 percent by the end of the year — a whopping annual increase considering they were zero a few weeks ago. That’s the equivalent of 14 rate hikes in a year.
“I would like to get there in the second half of this year,” he said. “We have to move.”
In addition to raising interest rates, the Federal Reserve plans to pull about $95 billion ($128 billion) a month out of the economy to curb demand. After pumping more than $5 trillion ($6.7 trillion) of newly minted cash into the economy during the pandemic, it is now reversing course.
American actions affect us directly. When US interest rates rise, it spills over to the rest of the world. Just like in the early 1990s.
Why Philip Lowe is gun-shy
If you can believe the money markets, we’re in exactly the same boat. The RBA believes it should be planning more than a dozen rate hikes by the middle of next year — a scenario that would put many of last year’s first-time buyers under extreme pressure.
It’s estimated that around half a trillion dollars are at stake after lending hit record highs last year as new entrants, lured by the prospect of years of super-cheap credit, took the plunge.
Last Friday the bank almost raised the white flag. After insisting for most of last year that interest rates would remain unchanged until around 2024, the latest Financial Stability Review raises some concerns.
RBA Governor Philip Lowe has insisted for months that rates would not rise until wage growth gets underway. But the first rate hike is now widely expected to be just around the corner, possibly as early as June, putting the RBA between the rocks and the very hard place it was desperately hoping to avoid.
And those two subheadings accurately outline her two major fears.
“Rising inflation and rising interest rates will make it harder for some borrowers to repay their debt.”
Then there’s this: “Large declines in real estate or financial asset prices would disrupt financial markets and the economy.”
Put simply, accelerating rate hikes could lead to extreme mortgage stress, possible loan defaults, a stock market crash and… a recession.
Our money tangerines have for years pointed to the large accumulation of overpayments that Australians have built up in their mortgage adjustment accounts as a reassuring buffer.
As the RBA chart below shows, it’s looking great on a median basis where we have almost 18 months of payments in the bank. But when you look at those who have only recently jumped on the mortgage bandwagon — many with six or more times their income — things look a lot tighter.
The pain is probably centered on the boys.
Is the recession a certainty?
The only certainty right now is uncertainty. Vladimir Putin’s brutal invasion of Ukraine may have backfired spectacularly, revealing the incompetence of his armed forces and the hollow structure of his regime. But it has thrown a curveball into the global economy.
Inflation was a problem even before the botched attack on its neighbors. Delays in restarting factories combined with low inventories and shipping restrictions constrained the global supply of a vast amount of trade goods, while the pandemic pulse in developed countries spurred demand.
But the exclusion of Russian raw materials and the disruption in trade relations have thrown the prices of energy, metals and grain into orbit. This is now being priced into goods and services across Europe, the United States and Asia Pacific.
If the global situation weren’t complicated enough, China appears to be in the early stages of a dramatic economic slowdown. Increasingly futile attempts to eliminate Omicron have led to widespread lockdowns, including 26 million in Shanghai, where residents are running out of food.
Its economy was already in trouble. Attempts to slow down the real estate sector led to widespread defaults, including at China Evergrande, which has sent shockwaves through the economy. This followed a regulatory purge of tech giants that rocked the Shanghai stock market.
While Beijing is sticking to its guns with forecasts of 5.5 percent growth this year, that looks unlikely.
If there is a potential savior, deteriorating global conditions could prompt central bankers to take a more cautious trajectory over the next six months than financial markets are predicting.
But the risk of political mistakes is increasing.