[HSC] Economist: 21–26 May
The week in review.
This week saw Philip Lowe once again voice concerns about the fragility of China’s financial system and consequently the sustainability of their economic growth. Global free trade was once again a hot topic, with Christine Lagarde stressing the importance of avoiding a global trade war. Additionally, housing prices are starting to fall, which will give hope to first-home buyers, but could transmit stresses to other parts of the economy. Finally, make sure you check out Ross Gittins’ rebuttal of the government’s claim that they’ve ended bracket creep once and for all.
1. Australia’s Relationship with China
Over the last forty years, China has experienced unparalleled rates of economic growth and become Australia’s most significant trading partner. This allowed Australia to avoid experiencing a technical recession during the Global Financial Crisis (GFC). However, in recent years there has been a significant increase in debt levels, with total debt forecast to be 260% of GDP by the end of the year. This poses a serious threat to the sustainability of China’s economic growth, and in turn Australia’s own economic performance.
RBA Governor Dr Philip Lowe, emphasised this concern in an address to the Australia-China Relations Institute, claiming that the buildup of this much debt, usually results in a financial crisis. The Chinese government has been seeking to reduce their debt-to-GDP ratio under President Xi Jinping, however, this is proving difficult given the size of their “shadow-banking” sector, which accounts for 45% of credit according to Lowe.
In recent months, a global trade war has emerged as a possible trigger for Chinese financial collapse. IMF modelling suggests that a breakdown in trade between the US and China could reduce China’s annual economic growth rate by 50 basis points, because one-fifth of Chinese exports are sent to the States. A contractionary shock of this magnitude would cause significant unemployment, which may result in individuals being unable to meet their debt obligations as a large proportion of China’s debt is in the form of long-term mortgages. This could spell disaster, as a similar situation in the United States just over a decade ago, was the catalyst for the GFC.
HSC Relevance
- China is Australia’s most significant economic partner, which means any shock emanating from China will be quickly transmitted to the domestic economy.
- In recent years, both Australia and China have experienced booming housing markets, resulting in the accrual of large amounts of debt.
- An inability to regulate the “shadow banking” sector, or the outbreak of a global trade war, could trigger a financial collapse in China.
- Compare and contrast the current situations in China and Australia with the events leading up to the GFC in the United States.
2. Free Trade and Protectionism
Australia has been encouraged to sign a free trade agreement with the United Kingdom once the Brexit process is complete. The McKell Institute — a policy thinktank — believes that an agreement between the two nations would be a positive step forward in a time of growing protectionism. The trend towards protection has been seen particularly in the UK with the Brexit decision, but there has also been a rise in protectionist pressures domestically. Furthermore, when arguing for an agreement to be signed Sam Crosby, executive director of McKell, claimed,
“Free trade, if done right, should bolster living standards and equality.”
Additionally, negotiations are underway between Australia and the European Union over a multilateral free trade agreement. Whilst the growth of China has been one of the primary drivers of the Australian economy in recent years, the EU remains a vitally important trade and investment partner. In 2017, trade between Australia and the EU was worth $100 billion and the EU was the largest source of foreign investment into Australia.
That being said, a large portion of these flows can be attributed to Britain. There are also concerns about the length of time the negotiations will take, which will reduce the impact of the agreement in the short-term.
Finally, Christine Lagarde, managing director of the International Monetary Fund (IMF) has been quoted as saying,
“the sun is shining on the global economy”.
The IMF forecasts the global economy to grow by 3.9% this year, however, there are a number threats to this growth, with growing protectionism, chief amongst them. As previously mentioned, many nations around the world have shifted towards more protectionist policies. This has been most embodied by the United States, with Donald Trump still mulling over imposing harsh restrictions on Chinese imports, which could be the catalyst for a global trade war. History tells us that this would be damaging to all countries, and the global economy would fall well short of the projected 3.9% growth.
HSC Relevance
- In an ideal scenario, freer trade leads to greater economic growth and improved standards of living.
- Trade agreements involving more than two nations are notoriously hard to arrange.
- How do increased protectionism and global trade wars lead to poorer economic outcomes for all involved?
3. Housing Market Wobble
During the four year period from 2013–2016, houses in Sydney appreciated by 42% and there were similar trends in the other capital cities. However, the housing boom is no more, with prices in Sydney down 3.4% in April, and Hobart being the only capital city to record substantial price rises. There are a couple of reasons for these falling prices. Firstly, there has been a substantial tightening of lending requirements over the past twelve months, with APRA raising the liquidity capital ratio (LCR) for banks and cracking down on interest-only loans. Secondly, there has been a substantial increase in the supply of residential buildings, particularly in New South Wales and Victoria.
However, whilst falling house prices make it easier for first-home buyers to get a foot in the door, it can cause problems for those who recently bought a property, at a highly inflated price. Australia’s household debt levels are at record highs and the level of mortgage stress — people struggling to meet monthly repayments — has been steadily rising. This problem could be exacerbated further as the banks seek to tighten lending practices in the wake of the royal commission. The RBA deciding to raise the cash rate would have a similar detrimental impact. The impacts of any crash would be severe for the Australian economy given the vast number of individuals holding substantial debt. However, the improved liquidity and solvency of financial institutions, in response to the experiences of the Global Financial Crisis, should help to minimise the damage.
HSC Relevance
- Australia experienced rapid house price inflation from 2013 to 2016, however, this is quickly changing, and a downturn in the housing sector could provide a contractionary shock to the broader economy.
- Examine how prudential regulation has changed in the wake of the GFC.
4. Elsewhere around the Globe
- The United Kingdom’s economy expanded by 0.1% in the first quarter of 2018, giving rise to an annual growth rate of only 1.2%, the lowest since 2012. Annual inflation in the United Kingdom fell from 2.5% in March, to 2.4% in April.
Further Reading
This series of weekly articles aims to compile the important economic news of the week into bite-sized summaries with HSC-specific takeaways.
You can expect a new article every Sunday at 6pm!
