• jmcdonnell64

This Downturn is Different

In some ways this downturn is similar to the global financial crisis: the stock market has crashed before it made a recovery on Tuesday and the developed world is once again confronted by the prospect of a recession. However there is a substantial difference between the two crises in so far as the GFC was a demand shock economic crisis whereas the coronavirus economic crisis is essentially a supply shock event.

The crisis is serious. There has been a 15% hit to the share market, which has also had a big effect on peoples superannuation balances just as they recover from the GFC.

During the Global Financial Crisis there was a shortage of liquidity so the central banks and governments pumped money into the global economy to keep it going. The problem with this solution was that governments and households accumulated debt that has taken years to wash through the system, which is why growth and wage growth has been anemic since the GFC.

The other major difference is that the GFC was concentrated in western developed countries. The Asian governments, particularly China, stimulated their economies which led to demand for Australian goods and services and was a major factor in keeping Australia out of recession.

This time around China is the epicenter of the crisis. Because of the coronavirus pandemic China has simply closed down production. This is a double whammy for Australia: we cannot get any goods for our supply chains and at the same time we cannot sell China our raw materials.

On top of this, the public health measures that have been taken to contain the virus, in particular the travel bans, have a major impact on the education and tourism sectors in Australia.

Supply shocks mean that there is a lot of pent up demand wanting to get their hands on goods that are currently unavailable. Many countries terms of trade will be stronger because of the cheap oil prices. This means that if the crisis is a short term one, which depends on how quickly a vaccine can be developed, then the recovery will be short and sharp compared with the slow recovery from the GFC.

In the meantime, the government needs to implement a set of measures that will keep the trade exposed sectors of the economy ticking over until the recovery begins.

The fact that China is so important to the Australian economy justifies Prime Minister Scott Morrison’s comment to a business forum on Tuesday that the crisis could be worse than the GFC. This was reinforced by a comment by former Treasurer, Peter Costello, that there may be a need for a second stimulus package in order to bridge the gap.

This is a pessimistic view of the global health response which takes the view that vaccines will not be available for some time. The indications are that the containment policies in China have worked and the impact of the disease has been largely confined to Hubei Province. This means that China is likely to get back to work sooner rather than later.

At the moment governments are focusing on the worst case scenario, which is the prudent thing to do and there has been a minor element of panic in the stock market reaction but this will not morph into a major recession if governments maintain a steady hand.

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