Lessons from Europe

The growing European financial crisis has been as predictable as it has been mismanaged. That the entitlement mentality and successive governments living beyond their taxpayer-funded means could never be sustained was obvious to anyone with half a modicum of common sense and economic understanding.

Historically, the way for sovereign nations to overcome their poor fiscal management was to default on their debts, create inflation or devalue their currency. Monetary union put paid to currency flexibility and default has been largely avoided at the cost of hundreds of billions of Euros from the European Central Bank. There are many who believe that these billions are only delaying the inevitable – a breakup of the European experiment as we know it.

The logic behind such conclusions is rather compelling. It is simply unfeasible for monetary union to be maintained while individual nations are not bound by similar budgetary requirements. Eurocrats say that this is why the national budgets of EU members should be run from the centralised authority in Brussels; truly a case of ‘the only way to solve the problems of centralisation is to have more of it’. It is the same reasoning used by those who seem to think the only way to solve a debt crisis is to actually borrow more money!

Personally, I think it’s inevitable that nations like Greece will break away from monetary union. They will seek to return to the Drachma as the only way to resurrect their moribund and debt-laden economy. This may also involve defaulting on the hundreds of billions of dollars in outstanding bonds issued to many European banks. This will naturally have implications for the European banking system, much of which is now underwritten by governments.

It may also encourage other nations to pursue a similar path. Portugal and Ireland are two notable candidates. So too are Italy and Spain, although the implications of such a decision by either of these two large economies would be far greater than the others combined.

While Europe is many thousands of kilometres away from Australia, we will not be immune to the financial upheaval expected to take place there. A great deal of our bank funding has come from Europe. This flow of funds, and that historically sourced from the United States, will be increasingly difficult to obtain. This will result in higher funding costs and credit finance becoming increasingly difficult to obtain.

In short, the 70-year credit-driven expansion of the global economy seems to be drawing to an end. The result will be increasing austerity as governments, business and families repair their balance sheet. The easy profits of credit-led, continually rising asset prices will no longer be the guaranteed ticket to riches that it has been.

The challenge for governments will be how to manage this transition to a new paradigm. This has the potential to further polarise the political debate, as seen already in parts of Europe. There are broadly two camps: the pro-growth camp who believe that continued borrowing will enable the economy to recover and the austerity camp who want debt repaid by taxpayers no matter what the civil cost.

So far Australia has been spared the brunt of the pain, although there are warning signs about the dangerous path ahead. Bond rates are forecasting a drop in interest rates to 2.5 per cent by next year. This suggests a strong economic slowdown in the next 12 months. On the flip side, international economic organisations expect Australia to be one of the standout growth stories of the world economy.

While I am predisposed to the former view, there are many in the other camp. Simply put, no one really knows and the uncertainty is hurting us all by stifling investment. Similar damage is also being caused by the uncertain political situation in this country. The Labor Government is balanced on a knife edge, we have a Prime Minister without the authority or gravitas normally attached to the office and a spasmodic and inconsistent policy agenda. All three have combined to virtually kill business and consumer confidence.

In order to best prepare for the unchartered economic waters ahead, we need to deliver more public confidence in the framework and approach to be taken in the years ahead. That cannot be done with the minority government we currently have. That is why an election is absolutely critical to ensuring Australia is best placed to withstand what is potentially the perfect economic storm gathering around the world.