Echoes of the 1990 recession
Slowing growth, rising debt and sharp falls in sentiment were all hallmarks of the 1990 recession. If today's employment data shows signs of deteriorating then we may be looking at the early stages of an economic slowdown.
During the lead into the 1990/1991 recession in Australia I was privileged to be working in the Federal Treasury – the Current Economic Conditions and Monetary Policy Sections, I think they were called.
Without giving away the national security issues associated the monetary policy debate, it was clear to even an Assistant Research Officer Grade 6 that the policy makers ignored, or at best massively down played, the liaison reports on the economic hardship that was being widely reported. Monetary policy had been tightened, the world economy had started to slow, fiscal settings had been tightened and the world economy was showing a few cracks.
But at that time, the monetary policy setting group looked at the current account deficit (yes, this was a target for monetary policy 20 years ago) and historical inflation, which meant it was very reluctant and therefore slow to ease monetary policy even though business and consumers were screaming about the economic pain that was becoming sharper as the wheels fell off.
Policy makers at that time also got blind-sided by a couple of 'surprisingly resilient' GDP reports from the Bureau of Statistics which lead them to view that things aren't half as bad as the surveys and anecdotes were suggesting. Alas, those 'surprisingly resilient' GDP reports were subsequently revised lower – to the point that confirmed that the economy was indeed in recession a quarter or so earlier than the data originally suggested.
On that point: did GDP really grow 0.6 per cent in the first quarter of 2008 as the ABS told us a week or two ago? I'm a little spooked by the fact that 75 per cent of that growth (0.5 percentage points of the 0.6 per cent) was attributed to the statistical discrepancy. Back in 1989 and 1990, it was also the case that the world economy was slowing, but because Australia's export links were so closely tied to the miracle economy – Japan it was then – and the rest of Asia was strong and growing, the slump in business and consumer sentiment was put down as self interested groups complaining about a short period of economic hardship or a partial reversal of the excesses of the 1980s. What's more, the labour market was tight, there were fears of wages accelerating and the fall in house prices was merely a welcome correction to what had been a frenzied house price bubble in 1987, 1988 and 1989. Hey, stop complaining! What was happening was an orderly correction from the excesses of the 1980s.
In the middle of 2008, consumer sentiment and business confidence indicators have slumped and are at levels not far removed from those seen in the lead into the early 1990s recession. The world economy is slowing, but hey, the commodities boom continues and Australia's links with the miracle economies of China and India will boost national income for years to come. The historical inflation rate is high and lower house prices will aid affordability, so policy needs to stay tight. The government even did its bit in the May Budget by tightening fiscal policy (a little) which will take money out of the economy just as the extreme tightness in monetary policy is starting to bite.
What's worrying now is that the household debt to household income ratio is now around 165 per cent (it was under 50 per cent in 1990) and 12 per cent of household disposable income is used to service that debt (it was 9 per cent in 1990). With mortgage rates up 150bps or more in the last year, the consumer sector is under the pump as it uses money for debt servicing and not consumption.
The common theme is that this time it's different.
The cynic in me is reminded of the NASDAQ at 5,000, house prices in California, Dublin and Barcelona, the fantastic virtues of AAA CDO's and now commodities. This time it's different accompanied each of those price bubbles and chatter about new paradigms was common.
I have a horrible feeling that the Australian economy has now stalled. I have been looking at some trends leading into the 1990 recession and the picture today. To be sure, there are many differences in the structure of the economy, the labour market, the global economic balance, the dynamics of capital markets and a whole host of other things. That said, there are some similarities emerging that at the very least, confirm the economy in the early stages of a significant slowdown, and at worst a hard landing.
Look at consumer sentiment. It has fallen 30 per cent over the past year and is at levels consistent with a recession. Interesting it started from a higher high so the proportionate fall to date is about as much as in the depths of the last recession. Retail Sales are starting to catch the slide leading into the last recession. Business confidence is also weak, but not quite as bad as the depth of the recession. Unfortunately, the history dates back to 1989 only, when confidence was already low, but the level now recorded is at least consistent with other monetary easing cycles. If business confidence falls any more, the economy will be in bad shape.
Employment remains resilient. Data today will be critical for news on the labour market. As can be seen during the lead into the last recession, when employment growth slowed, it plummeted. Interest rates comparisons are a bit flighty – not least because it was only as the recession began in 1990 that the RBA embraced a cash rate target. For this reason, the comparison is with the 90 day bank bill yield. Of course, the current monetary policy cycle has been unusually long – it is now six years since the first hike in this cycle. But suffice to say that the outlook for yields is bullish, especially as the economy slows.
The Australian dollar has a similarly restrictive influence on exports in both cycles. The joys of a floating exchange rate meant that it went up when interest rate differential were high, domestic growth was strong and global growth was buoyant. When the music stopped, so too did appreciation.
The level of inflation is of course very different and in the late 1980s, there was no target. That said, when the economy stalled and slipped into recession, the inflation rate slid.
The unemployment rate rose quickly after a long period of decline when the economy fell into recession. Of little note to date is the fact that the unemployment rate in Australia has already increased by 0.2 percentage points over the last few months. The update in a few hours will be interesting to see.
All up: The leading indicators are very weak and extremely tight monetary policy is working. Consumer demand is slowing, sentiment is weakening, borrowing is slowing and the economy is poised to retreat.
The RBA bit the bullet and hiked in late 2007 and early 2008 and it is tacking the inflation problem upfront.
The scenario remains whereby the RBA could take advantage of its pre-emptive tightenings and pre-emptively ease if it wants to avoid a repeat of the 1990s recession.
Stephen Koukoulas is global strategist, currency and fixed income research for TD Securities in London.
Without giving away the national security issues associated the monetary policy debate, it was clear to even an Assistant Research Officer Grade 6 that the policy makers ignored, or at best massively down played, the liaison reports on the economic hardship that was being widely reported. Monetary policy had been tightened, the world economy had started to slow, fiscal settings had been tightened and the world economy was showing a few cracks.
But at that time, the monetary policy setting group looked at the current account deficit (yes, this was a target for monetary policy 20 years ago) and historical inflation, which meant it was very reluctant and therefore slow to ease monetary policy even though business and consumers were screaming about the economic pain that was becoming sharper as the wheels fell off.
Policy makers at that time also got blind-sided by a couple of 'surprisingly resilient' GDP reports from the Bureau of Statistics which lead them to view that things aren't half as bad as the surveys and anecdotes were suggesting. Alas, those 'surprisingly resilient' GDP reports were subsequently revised lower – to the point that confirmed that the economy was indeed in recession a quarter or so earlier than the data originally suggested.
On that point: did GDP really grow 0.6 per cent in the first quarter of 2008 as the ABS told us a week or two ago? I'm a little spooked by the fact that 75 per cent of that growth (0.5 percentage points of the 0.6 per cent) was attributed to the statistical discrepancy. Back in 1989 and 1990, it was also the case that the world economy was slowing, but because Australia's export links were so closely tied to the miracle economy – Japan it was then – and the rest of Asia was strong and growing, the slump in business and consumer sentiment was put down as self interested groups complaining about a short period of economic hardship or a partial reversal of the excesses of the 1980s. What's more, the labour market was tight, there were fears of wages accelerating and the fall in house prices was merely a welcome correction to what had been a frenzied house price bubble in 1987, 1988 and 1989. Hey, stop complaining! What was happening was an orderly correction from the excesses of the 1980s.
In the middle of 2008, consumer sentiment and business confidence indicators have slumped and are at levels not far removed from those seen in the lead into the early 1990s recession. The world economy is slowing, but hey, the commodities boom continues and Australia's links with the miracle economies of China and India will boost national income for years to come. The historical inflation rate is high and lower house prices will aid affordability, so policy needs to stay tight. The government even did its bit in the May Budget by tightening fiscal policy (a little) which will take money out of the economy just as the extreme tightness in monetary policy is starting to bite.
What's worrying now is that the household debt to household income ratio is now around 165 per cent (it was under 50 per cent in 1990) and 12 per cent of household disposable income is used to service that debt (it was 9 per cent in 1990). With mortgage rates up 150bps or more in the last year, the consumer sector is under the pump as it uses money for debt servicing and not consumption.
The common theme is that this time it's different.
The cynic in me is reminded of the NASDAQ at 5,000, house prices in California, Dublin and Barcelona, the fantastic virtues of AAA CDO's and now commodities. This time it's different accompanied each of those price bubbles and chatter about new paradigms was common.
I have a horrible feeling that the Australian economy has now stalled. I have been looking at some trends leading into the 1990 recession and the picture today. To be sure, there are many differences in the structure of the economy, the labour market, the global economic balance, the dynamics of capital markets and a whole host of other things. That said, there are some similarities emerging that at the very least, confirm the economy in the early stages of a significant slowdown, and at worst a hard landing.
Look at consumer sentiment. It has fallen 30 per cent over the past year and is at levels consistent with a recession. Interesting it started from a higher high so the proportionate fall to date is about as much as in the depths of the last recession. Retail Sales are starting to catch the slide leading into the last recession. Business confidence is also weak, but not quite as bad as the depth of the recession. Unfortunately, the history dates back to 1989 only, when confidence was already low, but the level now recorded is at least consistent with other monetary easing cycles. If business confidence falls any more, the economy will be in bad shape.
Employment remains resilient. Data today will be critical for news on the labour market. As can be seen during the lead into the last recession, when employment growth slowed, it plummeted. Interest rates comparisons are a bit flighty – not least because it was only as the recession began in 1990 that the RBA embraced a cash rate target. For this reason, the comparison is with the 90 day bank bill yield. Of course, the current monetary policy cycle has been unusually long – it is now six years since the first hike in this cycle. But suffice to say that the outlook for yields is bullish, especially as the economy slows.
The Australian dollar has a similarly restrictive influence on exports in both cycles. The joys of a floating exchange rate meant that it went up when interest rate differential were high, domestic growth was strong and global growth was buoyant. When the music stopped, so too did appreciation.
The level of inflation is of course very different and in the late 1980s, there was no target. That said, when the economy stalled and slipped into recession, the inflation rate slid.
The unemployment rate rose quickly after a long period of decline when the economy fell into recession. Of little note to date is the fact that the unemployment rate in Australia has already increased by 0.2 percentage points over the last few months. The update in a few hours will be interesting to see.
All up: The leading indicators are very weak and extremely tight monetary policy is working. Consumer demand is slowing, sentiment is weakening, borrowing is slowing and the economy is poised to retreat.
The RBA bit the bullet and hiked in late 2007 and early 2008 and it is tacking the inflation problem upfront.
The scenario remains whereby the RBA could take advantage of its pre-emptive tightenings and pre-emptively ease if it wants to avoid a repeat of the 1990s recession.
Stephen Koukoulas is global strategist, currency and fixed income research for TD Securities in London.
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