The Australian share market has followed Wall street overnight and other global markets, with as much as $60 billion wiped in value throughout the day.
The Reserve Bank of Australia has cut the forecast for growth in Australia’s gross domestic product in 2011 by a percentage point, to 3.25%, down from an expected 4.25%. The All Ordinaries finished down 4.2%.
What was the trigger for this dive?
Fred McDougall: After the debt ceiling agreement was reached in the United States, people had 24 hours to evaluate it. It was seen to be somewhat inhibiting in terms of the US government’s ability to be able to stimulate the economy further. It cannot go and decide to increase expenditure because then it would have to borrow more and that would cause problems down the track.
Once investors had a look, they turned then to look at Europe in a somewhat more pessimistic frame of mind. They couldn’t see the EU making much progress.
Bruce Littleboy: Question marks over the fiscal ability of Spain and Italy to meet their sovereign debt obligations are hardly new. Troubling figures have actually been there for years and years.
So why would somebody wake up one morning and start to panic about this? It’s hard to give a rational reason.
European Central Bank chief Jean-Claude Trichet made some negative comments overnight about the prospect of debt-crisis contagion from Greece and Portugal spreading to other areas in Europe.
So then his comments were picked up by the wire services, and they spread around the news, and then every screen jockey (day trader) says, “well, the prices are coming down, so I better sell.” And then everybody else does.
And then the first thing in the morning, everybody will be sitting with their fingers on the “sell” button, ready to press it when the market opens.
Could we see this coming?
Fred McDougall: It’s not surprising to some extent. It’s been building up for a while. As Europe has struggled to find a solution to the debt problems of a number of countries in southern Europe and the United States has been extremely sluggish in terms of recovering from the GFC. I think it was inevitable that, as data continues to come out which was somewhat depressing, investors would start to worry about the likelihood of another recession.
Investors are being very cautious. I think they have taken a pessimistic view as to the likelihood of another recession.
Harry Scheule: To some degree, what you’re seeing doesn’t come as a surprise because the debt crisis that has been going on for three years now is partially a consequence of what happened in 2007 and 2008.
It shows how financial markets function. Financial markets do not move continuously but in step and are often accused of overreacting.
It is a combination of new information and market reaction. Yesterday, both José Barroso (President of the European Commission) and Jean-Claude Trichet (president of the European Central Bank) raised doubt that recent financial support to South-European states may be insufficient.
Over the last few days, the US they released negative new economic information, for example information on the labour market. All the new information coming out on the US market is very negative and a reflection of the past month. Due to reporting cycles, this information was partially unavailable to the broad markets until now. However, critical voices such as Marty Feldstein (George F. Baker Professor, Harvard University) have signalled this in their speeches.
This economic downturn may be different 2007 – 08 and may very well persist over the next months. The economy in general moves in cycles rather than randomly.
What will be the impact on Australia?
Harry Scheule: The first impact in Australia may include changes to the value of its currency as well as more generally to commodity prices. Australia is a relatively small country and very vulnerable to pressure from overseas.
Australia is currently doing very well over the past years but my concern is that this growth will not persist. My hope is that the contagion effects will be less severe as Australia’s debt levels are much lower than other countries.
We may see a reaction by the Reserve Bank of Australia in terms of interest rates, which depends on the degree of change in the economy, i.e. the industry and consumer behaviour.
The RBA has various goals: limit inflation and support economic growth of Australia. Inflation is on the upper end of the spectrum so that’s a concern and would indicate rates would have to go up. But at the same time, if the downturn in overseas markets was to impact Australia, then the rates would have to be lowered. The RBA would have to determine as to what issue is more predominant – inflation or the economic growth of Australia.
Does the market plunge indicate another global financial crisis?
Bruce Littleboy: Economists have an old joke that sharemarkets have predicted nine out the past four recessions, meaning that it’s very easy for people to put too much emphasis on the gyrations of the markets.
I think it was the economist Robert Hall who began one of his articles by saying that “We economists don’t understand sharemarkets and how they work.” So it’s one of those mysterious beasts that is swayed by herd views.
Economists are very good when we’re talking about people making rational, dispassionate decisions. But when people are making group decisions in an emotional state, then the standard approaches of analysis don’t work so well.
You can have huge mood swings in sharemakets, where any idiot can buy and sell share shares in a matter of seconds. It’s often not something that they contemplate and mull over – it’s often something that they make an instantaneous, greedy and panicked response to.
People seem to invent triggers for these sort of market declines after they occur. When you’ve got group behaviour, people ultimately just imitate what other people are doing.
When a landslide starts, it’s an academic exercise – in the pejorative sense – to try to determine which boulder was the first to slide down the hill.
Fred McDougall: It’s a matter of state of mind and psychology. At the moment, investors do not see a lot to cheer the market up. As time is ticking by, the concern is now that rather than see recovery, we might actually see a return to recession.
Why have gold and oil prices, along with bond markets, also fallen?
Bruce Littleboy: The equities markets, bond markets, gold and oil are all down, which might seem unusual. But asset markets often move together, or at least clumps of them move together.
When you would think that there was distrust about bond markets, then people would decide to move their money into shares. And that is what standard theory would suggest. But in this case we have markets swinging together, and investors are not substituting unattractive markets for attractive ones.
Usually you’d think an investor would say “well there’s a problem with the Eurozone, then perhaps I will invest in Australian bonds”. But we’re not seeing that kind of calm, and rational decision-making.
This is happening today because people in asset markets are uncertain about the future and they don’t have the information to enable themselves to make rational decisions.
It’s not like when you’re buying an apple and you can reach out and give it a sniff, and then decide whether or not to put it into your shopping trolley. These financial products like long-term bonds live for 10 or 20 years, and you have no idea what’s going to happen. So your view are going to be rather sensitive to what’s happening in the news.
If you don’t know what the future is likely to hold, then you do put additional emphasis on the specks of information that you have. Economists can scratch their heads about this kind of behaviour, but we have to take people as they are.
Will our trade relationship with China shield us from another global downturn?
Fred McDougall: The stock market has dropped by 4% this morning in Australia, which is quite a large drop. Australia will be affected but I suspect to a lesser extent because of our relationship with China.
China is still growing at a very substantial rate and so I think the effect will be somewhat muted by the fact that there will still be significant demand for our commodities.
I think the bulk of Australian investors have diversified through superannuation funds. After a while, you get somewhat hard skinned toward these ups and downs and since the vast majority of shares in Australia are held in superannuation funds, most would take a long term view and not be too fussed about the short term.
The last recession was more caused by prices in the financial markets. This one is much more related to the strength of the underlying economy.
Here it’s just lack of demand that’s the problem. Investors are being very, very conservative and not spending. Without spending, you are not stimulating demand and that doesn’t lead to employment and orders for equipment and machinery. So the economy is being somewhat depressed by lack of demand.