If the economy is booming, why is there also fear of a recession in the run-up to the 2022 elections?



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Raise your hand if you remember “the recession we had to have”. You show your age if you did.

As we enter this federal election, whoever wins would do best to remember the immortal words of former Prime Minister Paul Keating in November 1990, just as the economy was beginning to tip into the abyss.

The contraction back then wasn’t nearly as severe as the COVID-inspired plunge we’re coming out of now. But the after-effects were much more severe and lasted much longer.

The other startling difference was that, instead of an unpredictable pandemic that was beyond our control and wrecked our lives, the last great recession was caused entirely by ourselves.

We didn’t need it at all.

And at this time, warning lights are flashing. Again, we seem to have forgotten the lessons of history, and it is entirely possible that Western economies are on the cusp of many of the same policy mistakes that caused the great global downturn more than three decades ago.

Central banks such as the Bank of England caused the recession of the 1990s with sharp rises in interest rates.AP: Kirsty Wigglesworth

The recession of the 1990s was caused by central banks. After a decade of greed and excesses – culminating in a financial crisis triggered by a stock market crash – central banks decided to rein in runaway inflation with the only weapon at their disposal: interest rates.

They’ve taken 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, peaking at nearly 18 percent. Mortgages and business loans were well above that.

It had the desired effect; the resulting recession certainly killed inflation. But although the downturn was officially over by mid-1991, it took a decade for employment to recover, ruining millions of lives.

Could it happen again?

Bill Dudley certainly thinks so.

Former New York Federal Reserve president Dudley says the Fed has waited far too long to take action on inflation.

According to Dudley, if the Fed wants to contain runaway prices — which is an 8 percent high in 40 years — it will have to raise interest rates to a point that will plunge the stock market and drive up unemployment.

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“That means the Fed needs to do more to slow the economy,” he told Bloomberg last week.

“The Fed will have to tighten enough to drive up unemployment and if the Fed has done that in the past, it has always led to a recession.

“That’s not their intention – they will go for a soft landing – but their chances of getting it done are very, very low.”

He seems to have guessed the mood correctly.

On cue, James Bullard, president of the St. Louis Fed, said Friday that U.S. interest rates could rise to 3.5 percent by the end of the year — a huge annual increase, considering they hit zero a few weeks ago. That is equivalent to 14 rate hikes in one year.

“I would like to be there in the second half of this year,” he said. “We have to move.”

On top of the rate hikes, the US Federal Reserve wants to pull about $95 billion ($128 billion) a month out of the economy in an effort to reduce demand. After pumping more than $5 trillion ($6.7 trillion) of newly minted cash into the economy during the pandemic, it is now turning off course.

American actions have an immediate impact on us. 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 are to believe the money markets, we are in exactly the same boat. The RBA, according to their calculations, should be planning more than a dozen rate hikes by mid-next year — a scenario that would put extreme pressure on many of last year’s first-time homebuyers.

It is estimated that about half a trillion dollars is at stake after last year’s credit spurts hit record levels when new entrants, seduced by the prospect of years of super-cheap loans, took the plunge.

Australian Home Loan Booming Chart
Source: Australian Bureau of Statistics

Last Friday, the bank virtually raised the white flag. After pushing for most of last year that rates should remain unchanged until about 2024, the latest Financial Stability Review is cause for some concern.

For months, RBA Governor Philip Lowe has maintained that rates would not rise until wage growth gets underway. But now the first rate hike is widely expected to be imminent, possibly as early as June, putting the RBA between the rock and the very hard place it was desperately hoping to avoid.

And these two subtitles neatly outline the two great fears.

“Rising inflation and interest rates will make it difficult for some borrowers to meet debt repayments.”

And then there’s this: “Large falls in real estate or financial asset prices would be disruptive to financial markets and the economy.”

Simply put, accelerated rate hikes can lead to extreme mortgage stress, potential defaults, a stock market crash and… recession.

Our money mandarins have for years pointed to the surge in excess payments Australians have built up on their mortgage accounts as a reassuring buffer.

As the RBA chart below shows, it looks great on a median basis as we’ve had almost 18 months in payments. But if you zoom in on those who have only recently jumped on the mortgage train — many with six or more times their earnings — things look a lot tighter.

A chart shows a sharp rise in the median chart between 2019 and 2022 with a relatively stable 25th percentile.
Mortgage buffers.Source: Reserve Bank of Australia

The pain is likely to be concentrated among the young.

Is recession a certainty?

The only certainty at the moment is uncertainty. Vladimir Putin’s relentless invasion of Ukraine may have backfired spectacularly, demonstrating the incompetence of his armed forces and the hollow structure of his regime. But it has thrown a crooked ball into the global economy.

Inflation was already a problem before the failed attack on its neighbor. Delays in factory restarts coupled with low inventories and transportation restrictions have limited the global supply of a vast amount of traded goods, just as pandemic stimulus in the developed world has fueled demand.

But the exclusion of Russian raw materials and the disruption of trade relations have sent prices for energy, metals and grain into orbit. That is now being priced into goods and services in Europe, the United States and Asia-Pacific.

If the global situation wasn’t complicated enough, China appears to be already in the early stages of a dramatic economic slowdown. The increasingly futile efforts to eliminate Omicron have led to widespread lockdowns, including 26 million in Shanghai, where residents are food deprived.

The economy was already in trouble. Attempts to slow the real estate sector have led to widespread defaults, including for China Evergrande, which has sent shockwaves through the economy. That came on the heels of a regulatory purge of tech giants that rocked the Shanghai stock market.

Although Beijing is sticking to forecasts of 5.5 percent growth this year, that seems unlikely.

If there is one potential savior, deteriorating global conditions could lead central bankers to take a more cautious path over the next six months than financial markets are predicting.

But the risk of policy errors is increasing.

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The main battlegrounds in the 2022 federal election.

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