Contagion

From my research there appears to be a recurring theme that could lead to Australia’s downfall and it is an important problem in any financial crises, contagion.

Australia has put all its ‘eggs in China’s basket’ and relies heavily on it for industry and investment. If demand from China falls Australia will greatly feel the effects especially in the resource industries such as mining, however I think maintaining such a close relationship with China has put Australia in a better position than one with say the US or Europe.

There is a high risk of contagion between the property bubble and banking. Housing prices have increased by approximately 300% over the last 10 years, the same increase Ireland saw from 1992 to 2006! The threat of the bubble bursting seems to be looming over Australia and depending if it makes a big bang or if it slowly deflates there will be wide-ranging effects on banking and its economy.

What does this mean for the future of Australia? I think it is essential for Australia’s banks to take the threat of the property bubble seriously, paying close attention to the risks involved and how best to endure the inevitable bursting of the bubble. Australia may suffer a similar outcome to that of Ireland’s housing bubble although I doubt the consequences will be quite as bad. A lot may depend on what is happening in other countries and if it will spread to Australia through panic and lack of confidence by consumers. The RBA however appear not to be panicking, interest rates have been steady at 4.25% during the start of 2012 sending a positive picture of the economy, but this confidence may be misplaced according to many economists who expected interest rates to be reduced. Even with the possibility of a crisis ahead is Australia still a better place to live? Well with an unemployment rate of 5.1% compared to the 14.2% unemployment rate of Ireland, and with 4 of the top 10 most liveable cities in the world according to The Economist…the grass may indeed be greener!

The Four Pillars

A little history, Australian banks were tightly regulated with controls over services, banks, exchange rates and foreign bank entry. Then in the 1980’s following The Campbell Inquiry a change took place and deregulation slowly was implemented to help increase efficiency and competition. This means that today the central bank of Australia, The Reserve Bank of Australia (RBA), can make decisions independently of political policy. It is primarily concerned with the stability of the currency and uses monetary policy to achieve inflation targets of 2-3%. It manages short term interest rates and influences cash rates to help stabilize the economy quite successfully. During the beginning of the global economic crisis, inflation in Australia reached a high of 5% in 2008 before falling to a low of 1.3% the following year. By the end of 2011 the consumer price inflation in Australia appeared to have eased to 3.1% after reaching a high of 3.6% during the year, although still on target this allowed the RBA to shift monetary policy and reduce the interest rate to 4.25% to boost the economy and pass the lower rates onto the borrowers. The RBA appears to be acting cautiously as they still have scope to further reduce the interest rate in case the global crisis worsens.

According to McDonald & Marling (2011) and Pais & Stork (2011) Australian banks appear to have escaped the crisis and are in a strong stable position showing resilience to the global downturn. They have remained profitable and maintained their credit ratings. In fact during 2009 Australia’s top 4, known as the ‘pillar’ banks, entered the world’s top 20 safest banks for the first time. This is an encouraging sign to the economy and gives confidence to Australians. The interbank market also appears to have fared well however as the ‘pillar’ banks maintain a strong link to each other but it may only take one failure to lead to a full on crisis!