Australia’s Recession Hits — The Sharpest fall in GDP, Ever
In the past 29 years, from late 1991 to early 2020 prior to the COVID-19 pandemic, the US suffered two recessions beginning in 2001 and 2007.
During that same period, Australia had a grand total of zero recessions. None, nein, nada.
Australia had a recession that ended in late 1991.
Then it went 29 years, through the Tequila Crisis of 1994, the Asian and Russian crises of 1998, the dotcom meltdown of 2000, and the global financial crisis of 2007–09, without a scratch.
Australia certainly lived up to its unofficial nickname as the Lucky Country.
Unfortunately for Australia, that winning streak (the longest among developed economies) ended abruptly in the second quarter of 2020.
Gross domestic product in Australia fell 7% in the second quarter compared to the prior quarter.
That was the sharpest quarterly fall in GDP since Australian records began in 1959.
The second quarter contraction came after a first quarter decline of 0.3%. The back-to-back quarters of declining GDP put Australia in a technical recession…
China propped Australia up
The main reason Australia avoided a recession in 2007 (and is in a recession today) is China.
In the 2007–09 global financial crisis, China performed fairly well. China did not suffer the mortgage and banking crises that swept through the US and Europe.
Its reserve position was strong (a lesson learned after the 1997–98 Asian financial crisis) and it continued to grow through infrastructure investment. That meant that huge exports from Australia continued, which meant that the Australian economy continued to grow.
The 2020 crisis is different. China was in the eye of the storm because the pandemic was centred in Wuhan, in China’s Hubei Province.
As the virus spread worldwide, global demand collapsed and China’s exports and manufacturing ground to a near halt. China’s imports from Australia collapsed and Australia itself was finally thrown into recession.
Relations between China and Australia then took a nosedive for reasons other than the recession. Australia was a world leader in demanding an independent expert investigation into the source of the Wuhan virus.
This included a call to look at the possibility that the virus was released from a biological research laboratory in Wuhan and not from an outdoor ‘wet market’ as the Chinese have maintained. (My research indicates that the theory that the virus was released from a laboratory is probably correct.)
China was infuriated that Australia was shining a light on their mishandling of the virus and criminal negligence in its cover-up of the early stages of the pandemic.
China hit back hard with economic warfare aimed at Australia. This has now escalated into tit-for-tat harassment of journalists, businesspeople, diplomats, and scholars in both countries.
On 9 September 2020, Reuters reported that Australia had revoked the visas of two Chinese scholars working in Australia.
The two scholars, Li Jianjun and Chen Hong, had both received letters informing them that they were considered threats to national security by the Australia Home Affairs Department (similar to the US Department of Homeland Security).
Also on 9 September, Australia’s ABC News reported that two prominent Chinese media officials in Australia, Tao Shelan of the China News Service and Li Dayong of China Radio International, had their homes raided by Australian security officials as part of a joint investigation by the Australian Federal Police and the Australian Security Intelligence Organisation.
These raids and the investigation may have been part of a broader investigation into Chinese efforts to infiltrate the New South Wales Parliament through a staffer or a Labor Party member.
These investigations and visa revocations are part of a much broader effort by both sides to expel journalists, scholars, and diplomats suspected rightly or wrongly of spying or interfering in internal political processes.
In years past, there was some restraint and reciprocity in such matters. If China expelled one Australian diplomat, Australia might expel one Chinese in response and that would be the end of that matter.
Up — down — up — ?
Today, escalation is the norm where China expels three Australians and Australia expels four Chinese and so on. Events may go downhill to the point where there are relatively few journalists or diplomats left on either side.
The dispute between Australia and China goes far beyond visas and journalists. China is Australia’s largest export market.
The Australian economy depends on exports of iron ore, gold, copper, and agricultural produce to China for a large part of its GDP.
China has been systematically curtailing imports from Australia and redirecting its purchases to other providers such as Brazil, Chile, and Peru.
With Australia suffering its first recession in almost 30 years and witnessing deteriorating trade and diplomatic relations with its main trading partner China, what are the prospects for Australian equities in the months ahead?
Right now, my analysis says Australian equities are set for a fall.
The Australian market has followed a similar up-down-up pattern to equity markets worldwide.
The question is whether every stock or ETF can sustain its recent strength. The pattern of recent strength suggests either that the stock or ETF is unaffected by the COVID-19 pandemic, or it will benefit from so-called ‘pent-up demand’ and a V-shaped recovery.
Yet, the evidence for a V-shaped recovery is scant…
Australia isn’t the only one in trouble
Job creation has resumed, but it has not come close to restoring the level of employment that existed earlier in 2020. Economic growth has resumed, but the pace is also not close to recovering the severe collapse in output experienced in the second quarter of 2020.
The best estimates are that early 2019 output levels will not be recovered until 2023, and 2019 employment levels will not be recovered until 2025 at the earliest.
So, why have stock prices recovered while output and employment have not?
The most important factor in explaining stock prices is monetary policy.
All of the world’s major central banks including the Federal Reserve, the Bank of England, the European Central Bank, the Bank of Japan, and the Reserve Bank of Australia have printed money, monetised government debt, and cut interest rates in unison and to an unprecedented extent.
This massive monetary easing did prevent the economic crisis from turning into a financial crisis. It helped to maintain liquidity and functioning markets.
But, contrary to the expectations of many observers, it did not result in consumer price inflation. The consumer was on strike, busy paying down debt and increasing savings because of the uncertainty resulting from both the pandemic and the new depression.
Instead, the central bank money went into asset price bubbles in stocks, bonds, and residential real estate. Stock markets from Sydney to London to New York were the main beneficiaries.
This monetary expansion (and related fiscal expansion in the form of deficit spending) did act as a kind of bridge loan in getting the economy from the worst part of the pandemic in March to an expected reopening and recovery in August.
The problem is that the reopening never happened, and the recovery is uneven.
The case load and fatalities of the pandemic are still increasing (albeit at a slower pace) and the reopening has been offset by new lockdowns in many localities.
It’s not clear that more monetary or fiscal ease are on the way.
With rates at or near zero, bloated balance sheets, and historically high debt-to-GDP ratios, the developed economies are calling a time out on more ‘stimulus’ (which is of doubtful stimulative effect in any case).
A lack of fiscal and monetary firepower and troubled relations with China are not the only headwinds Australia is facing.
The Australian dollar will also come under pressure in terms of its exchange rate with the US dollar.
Right now, the Fed policy rate for Fed Funds is 0.00–0.25%.
The policy rate for the Reserve Bank of Australia (RBA) is 0.25%.
But, the Fed has taken policy further and declared that they will not raise rates until inflation of 2% or more is achieved on a sustainable basis. That goal is not likely to be met for years, if ever.
These developments put the Fed at ‘maximum ease’ while the RBA still has room to ease further in the form of more money printing and forward guidance.
All the best,
Strategist, The Daily Reckoning Australia
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