Put your hand up if you remember “the recession we had to have”. You’re showing your age if you did.
As we head into this federal election, whoever wins would do best to remember those immortal words from former prime minister Paul Keating back in November 1990, just as the economy began to tip into the abyss.
The contraction back then was nowhere near as severe as the COVID-inspired plunge from which we are now emerging. But the after-effects were far more severe and lasted a great deal longer.
The other startling difference was that, instead of an unpredictable pandemic well beyond our control wreaking havoc on our lives, the last great recession was entirely of our own making.
We didn’t have to have it at all.
And right now, warning lights are flashing. Once again, we appear to have forgotten the lessons of history, and it is quite possible western economies are about to commit many of the same policy mistakes that caused the great global downturn more than three decades ago.
The 1990s recession was engineered by central banks. After a decade of greed and excess – culminating in a financial crisis brought on by a stock market crash – central banks decided to rein in runaway inflation with the only weapon at their disposal: interest rates.
They hiked them to ridiculous levels and kept them there. In the two years up to January 1990, the Reserve Bank pumped rates up by 7 percentage points, peaking at close to 18 per cent. Mortgages and business loans were well above that.
It had the desired effect; the resulting recession certainly killed inflation. But while the downturn was officially over by the middle of 1991, it took a decade for employment to recover, ruining the lives of millions.
Could it happen again?
Bill Dudley certainly thinks so.
The former president of the New York Federal Reserve, Dudley reckons the Fed has waited far too long to take action on inflation.
According to Dudley, if the Fed wants to contain runaway prices – which at 8 per cent is a 40-year high – it is going to have to raise interest rates to a point that triggers a stock market rout and forces unemployment higher.
“That means the Fed has to do more to slow down the economy,” he told Bloomberg last week.
“The Fed is going to have to tighten enough to push up the unemployment rate and when the Fed has done that in the past, it’s always resulted in a recession.
“That’s not their intention – they’ll go for a soft landing – but their chances of pulling it off are very, very low.”
He seems to have gauged the mood correctly.
On cue, St Louis Fed President James Bullard on Friday said US rates could rise to 3.5 per cent by this year’s end – a huge annual hike, given they were at zero a few weeks back. It’s the equivalent of 14 rate hikes in one year.
“I would like to get there in the second half of this year,” he said. “We have to move.”
On top of the rate hikes, the US Federal Reserve is looking at pulling around $ US95 billion ($ 128 billion) a month out of the economy in a bid to shrink demand. Having pumped more than $ US5 trillion ($ 6.7 trillion) in newly minted cash into the economy during the pandemic, it is now reversing course.
American actions have an immediate impact upon us. If US interest rates rise, that flows through to the rest of the world. Just like it did in the early 1990s.
Why Philip Lowe is gun-shy
If you can believe money markets, we are in exactly the same boat. The RBA, according to their reckoning, should be planning for more than a dozen rate hikes by midway next year – a scenario that would put many of last year’s first-home buyers under extreme pressure.
It’s estimated around half a trillion dollars is on the line after the splurge in lending last year to record levels as new entrants, enticed by the prospect of years of super-cheap loans, took the plunge.
Last Friday, the bank all but raised the white flag. After insisting through most of last year that rates would stay on hold until around 2024, the latest Financial Stability Review is cause for some alarm.
For months, the RBA governor Philip Lowe has insisted rates would not rise until wages growth kicks into gear. But it’s now widely anticipated the first rate hike is just around the corner, possibly as early as June, placing the RBA between the rock and the very hard place it desperately was hoping to avoid.
And these two sub-headings neatly outline its two great fears.
“Rising inflation and interest rates will make it difficult for some borrowers to meet debt repayments.”
Then there’s this: “Large falls in property or financial asset prices would be disruptive for financial markets and the economy.”
Put simply, accelerated rate hikes could lead to extreme mortgage stress, possible loan defaults, a stock market crash and… recession.
Our money mandarins for years have pointed to the large build-up of excess payments Australians have built up in their mortgage offset accounts as a comforting buffer.
As the RBA graph below shows, it looks terrific on a median basis where we have almost 18 months of payments banked. But when you drill down to those who have only recently jumped aboard the mortgage train – many at six or more times their earnings – things look far tighter.
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