The markets may have been reassured by Mario Draghi’s "whatever it takes" jaw-boning overnight but while Europe continues to dither over a comprehensive response to its crisis the risk of another global crisis remains.
The European Central Bank buying some sovereign debt to lower funding costs for insolvent governments won’t resolve the eurozone’s crisis and it appears that the only obvious pathway to a resolution – Germany writing a blank cheque – isn’t politically feasible.
That suggests Europe, and the world, will remain on the brink for quite some time with the most optimistic outcome being that the Europeans will continue to find some way to muddle through.
What if they can’t? What if we have to confront another global crisis similar to that experienced in 2008 and 2009? Are we any better prepared to cope with it?
In some respects, we are. In 2008 the US banking system melted down and had to be bailed out by US taxpayers at a massive cost. Today the US system has been recapitalised, is holding a lot of liquidity and its riskiest exposure substantially wound down. Its corporate sector is more profitable and hanging onto a lot of cash.
The US government, however, as a result of the mountain of debt and the deficits that were exacerbated by the response to the crisis has little flexibility to respond to another, other than by printing more money. The Federal Reserve Board is already effectively running a zero interest rate policy and, despite the talk about QE3, has used up its unconventional policy measures.
There would be limited ability to stimulate what is an already very weak US economy.
Last time China’s economic growth dove as the crisis developed and the Chinese authorities responded with a massive stimulus program. They have the capacity to do the same again but there is little doubt that their economy, and its demand for commodities, would also be adversely impacted again.
What about Australia? Our major banks are, as a group, arguably the strongest in the globe. They are conservatively capitalised, are holding massive amounts of liquidity, have clean balance sheets and have significantly reduced their exposure to wholesale funding markets, particularly short-term funding markets.
The corporate sector is less highly geared than it was in 2008 – the A-REIT sector which was hit hard by the original crisis has deleveraged and we don’t have the big listed and leveraged infrastructure funds that we did in 2008. The original crisis also highlighted the remarkable capacity of the Australian sharemarket to provide equity funding, even in those circumstances.
But, as Deloitte Access Economics’ Chris Richardson said in his KGB Interview published today, while there is "heaps of capacity" to respond to another crisis, there are some differences to the starting points in 2008 and today, and not all of them are positive.
As he says, with among the world’s highest real interest rates, the Reserve Bank in theory still has a lot of monetary policy firepower it could bring to bear on another crisis. It does, however, have less than it did entering the original crisis.
It’s also unclear whether looser monetary policy would have the same effect as it did then. The flip side of the very positive shift in emphasis by the major banks from wholesale funding to deposit funding is that they have bid up the cost of deposits relative to the cash rate. In a new crisis, they would be desperate to retain and build those deposit bases to further reduce their need for wholesale funding.
As Richardson acknowledged, no matter how much the RBA reduced official rates, there is no certainty that cuts would be fully passed on by the banks.
The RBA does, of course, have the ability to provide liquidity to the system and, indeed, has created a mechanism for the banks to get access to RBA-sourced funding, at a price, if necessary. The federal government could also reinstate the wholesale funding guarantees that worked successfully through the last crisis.
The economy would inevitably be hit hard by another crisis and global economic downturn, particularly if China’s growth rate dived. Commodity prices, already way off their peaks, would drop sharply and impact our terms of trade, although a lower dollar would blunt some of the impacts.
The fact that there is still so much resource and infrastructure already underway but yet to be completed would act as a dampener of the economic impacts of another crisis – there are a large number of mega projects far too advanced to be halted.
The federal government, which last time oversaw one of the world’s largest stimulus programs – about 8 per cent of GDP – still has significant financial capacity to respond to another crisis but it is doubtful whether either of the major parties would have the will to embark on a fiscal splurge on a similar scale, given the fixation with debt and deficits.
Richardson doesn’t see another crisis as the most probable outcome of the eurozone’s troubles. He’s in the "muddle through" camp and so far, at least, the Europeans have been able to continue to kick an increasingly battered and fragile can down the road.
If they can’t, however, while the rest of the world is probably better prepared in many respects for a repeat of 2008 the legacies of that earlier crisis will also restrict its ability to respond. Let’s hope Richardson is right.