Does the stimulus really matter? Kohler

If the US Congress is having trouble passing an emergency stimulus bill after the American economy has already been in recession for 14 months, what hope does Kevin Rudd have getting one through Australia’s Federal Argument, I mean Parliament, with employment apparently rising?

And does it matter?

Well, US stocks have fallen 5% in a couple of days, but that’s not because of wrangling about the fiscal package but rather concerns about bank solvency.

In Australia the market has fallen only 1.5% because the banks are solvent and some reasonably good profits results are coming through.

And also because Rio has opened the door on its dungeon of Chinese degradation and a frisson of excitement has rippled through the voyeurs.

It is important to keep in mind that the fundamental problem with the global economy is a massive collapse of the value of debt as a result of the bursting of a credit bubble. That led to a collapse in the value of property assets and sharemarket ratings, but those are subsidiary effects.

Loan securities, bank loans and credit derivatives have fallen in value by anything between 60% and 99%; those who own these assets – mainly banks, but also investment banks and hedge funds – are now largely insolvent as a result.

That’s because there is nothing right on the left side of their balance sheets and nothing left on right side, to quote an old joke.

In Australia, the fact that average residential house prices only fell 2% to 3% last year has meant that the domestic debt market has not collapsed to anything like the same extent as in the US, Britain and Japan.

This has supported strong bank lending and therefore consumer spending, which has in turn kept unemployment under 5% (so far).

So while the Australian sharemarket has fallen by half, causing massive disruption to retirement savings and increasing capital costs for companies, the banks are in good shape and the politicians can fiddle contentedly because it doesn’t look like Rome is burning.

Australia’s problem, when it comes, is going to be a collapse in both business investment and the terms of trade.

It’s true that Australia’s household debt is very high so that it can be argued that the imbalances here are as bad as those in the US and Britain, but the fact is that this crisis has no domestic cause – unlike both the 1982 and 1991 recessions (they had global causes as well, of course, but Australia was mostly the author of its own misery).

This time it is a purely imported contagion because both the Reserve Bank and the Government have generally performed beautifully over the past decade.

That means the crisis will operate primarily on our external accounts – that is, the terms of trade and the resources boom – and on those who rely on foreign capital, which has dried up; that is, businesses.

Australian banks are getting plenty of foreign capital at present because they are guaranteed by the Government; without that, they would be in trouble.

The fiscal stimulus packages are an attempt to deal with symptoms, not causes.

And because governments are using them as an expression of their political and ideological fancies, rather than simply taking the advice of economists about where the money should go to best help employment, they have invited their opponents to do the same.

As a result, the debates over fiscal stimulus have descended into arguments over favourite causes (education versus the Murray Darling basin etc) rather than the greatest economic efficacy.

But in any case the crisis won’t end until either the debt market miraculously recovers, or the owners of the assets that have collapsed in value (that is, the banks and their loans and loan securities and derivatives) recognise and deal with their losses.

Much of last week’s rally on Wall Street seems to have been based on a hope that mark-to-market accounting would be modified or abandoned, so the banks would not have to keep writing down the value of their loans and loan securities in their balance sheets, and then everything would be alright.

This week’s reversal in the market back to where it was at the start of February is the evaporation of that hope, and the realisation that Timothy Geithner, the new US Treasury Secretary, can’t save them, or doesn’t know how to.

This article first appeared on Business Spectator