Don’t be fooled – this recession is just getting started and it will be ugly: Kohler

The OECD’s latest economic outlook report is, or should be, a glass of cold water in the face.

There is an air of complacent unreality in Australia at present, as if this country can somehow escape the “great recession”. The ACTU even has a claim in for a general pay rise!

When I travel around talking to groups and individuals about the crisis these days, what everyone wants to know is; when will it be over? In fact the question should be: When will it begin?

Australia has so far been cocooned by political and economic insouciance and prettied up by well-targeted government mascara – the bank deposit guarantee, and state government debt guarantees, the short selling ban on financials, the first home buyer grant, the 30% extra tax deduction for business investment until 30 June, and of course the huge fiscal stimulus, and especially the cash handouts.

We also steadfastly cling to the “technical definition” of recession – two consecutive quarters of negative GDP – which means we won’t have to admit to being in recession until early June, when the March quarter national accounts are released.

And so when RBA Deputy Governor Ric Battellino, quietly dropped in a speech in Brisbane yesterday that GDP is likely to fall in 2009, it was news. The rest of the world long ago came to terms with this; Australia still has not, and by the weekend will probably go back to thinking we can avoid recession.

The OECD’s forecast of a 4.3% global GDP contraction this year is shocking enough, but a further 0.1% contraction is forecast for 2010, with risks “tilted to the downside”.

Unemployment in the OECD is projected to be still rising when Australia is due to hold its next federal election. Specific forecasts for Australian GDP and unemployment next year are not included.

I think the most bracing thing about the OECD’s report this morning is its commentary on world trade, and in particular the following statement in Box 1.2 on page 19 of Chapter 1, headed “International Trade in Free Fall”.

“The trade forecast associated with this interim economic outlook is in line with the models…under the assumption that the unexplained part of trade contraction is a one-off shift in the trade level for which the main reasons still have to be identified.”

In other words the collapse in world trade is worse than anything seen before and is a mystery that can’t be explained either by history or the OECD’s models.

After growing steadily for decades at an annual rate of 8% (the era of globalisation), global trade has fallen at a rate of 20% in the last quarter of 2008 and the first quarter of 2009.

The value of exports from non-OECD Asia fell at an average rate of 30% over this period. As a result industrial production has collapsed.

And the OECD says it cannot explain it, either with short-term leading indicators of growth or modelling the effect of global credit conditions on trade finance. As a result it has simply put a “one-off” drop in trade into its projections and left it there.

Maybe trade will come back just as quickly, because the sharpness of the decline is caused by the sophisticated global supply chains that have been developed and that could just as easily work in the opposite direction. Against that, the OECD points to a very large build-up of inventories that need to be cleared, especially in Japan.

The OECD report also looks in detail at the effect of falling house prices, which it says are likely to be a further drag on activity this year and next. House prices are now falling in “virtually all” OECD countries (including Australia, notwithstanding yesterday’s report from Rismark and RP Data, showing a rise in February) and housing investment is in decline.

The report concludes that the risks to its already grim forecasts are skewed to the downside for several reasons:

•     Mortgage delinquency rates are already worse than in 1990, but “with the current recession set to be much worse” default rates will end up being worse as well and could set up a further feedback loop between the financial sector and the real economy.

•     Delinquency rates on commercial mortgages could catch up with residential mortgages.

•     Bank balance sheets in some countries are at risk due to cross-border lending – especially in eastern Europe (by the way, Ukraine yesterday said its GDP has contracted by a third).

•     Although equity markets seem to have priced in significant cuts in profits and dividends with price earnings ratios well below historical norms, surprises on the downside could drive them down further.

•     The fiscal stimulus multipliers could be less than usual because of “impaired functioning of financial markets, heightened uncertainty and the desire of households and business to repair balance sheets as a result of massive capital losses on equity and home values”.

But of course none of this could happen here, could it?

This article first appeared on Business Spectator