A nice speech from Ric Battellino, Deputy Governor of the Reserve Bank of Australia.
He points that in 1980s and 1990s whenever US sneezed, Aussie economy caught a cold. This was puzzling as they did not have major trade linkages which was seen as a strong factor:
Through the 1980s and into the 1990s, developments in the Australian economy showed a close correlation with those in the US economy. It was particularly striking that the recessions of the early 1970s, early 1980s and early 1990s were highly synchronised between the two countries and had many similarities in their nature and origins. As a result, it was common in the 1980s and 1990s to hear the phrase “when the US sneezes, Australia catches a cold”.
Australian economists, including those in the Reserve Bank, spent a lot of time researching the question of why growth in the Australian economy was so highly correlated with that in the US. We were intrigued by the closeness of the relationship because the trade flows between the two economies were not particularly large. The United States has always been only a moderately important export destination for Australia.
However because of stronger financial and cultural ties, both had similar shocks:
First, the economic shocks faced by the two countries in the lead up to the recessions of the 1980s and 1990s were similar, as were the policy responses.
Second, the financial and cultural links between the two countries have always been very strong. The United States is a large investor in Australia and many Australian companies have operations in the US. US economic news receives very wide coverage in the Australian media. This, in turn, has often promoted very similar movements in financial prices, business sentiment, and even household behaviour.
However it started to differ post 2000s. Aussies were not effected much by both 2001 and 2007 recessions. He points to some reasons for this divergence:
- Both 2001 and 2007 were because of financial adventures gone bad. Aus avoided both esp tech bubble and was actually ridiculed for being an old economy.
- As it was not impacted by 2001 recession, RBA was able to raise policy rates much quicker than Fed. So, it avoided the housing bubble as well.
- Australian Prudential Regulation Authority (APRA), the prudential supervisor, pressed the banks to maintain relatively high lending standards. This helped as well. There was limited subprime lending.
Apart from this he highlights role of China. Australia has moved its trade increasingly to China. They are a natural fit as Australia has huge natural resources and China has huge demand for them.
Arguably, Australia is one of the economies that most complements the Chinese economy. It is a large producer of food, energy, basic materials and education and tourism services – products and services for which China has a very strong demand – while the limited size and specialised nature of Australia’s manufacturing sector mean that the economy as a whole is not facing wide-scale competitive pressures from China. As evidence of this, over the past decade Australia has experienced a much larger rise in its terms of trade than all other major commodity exporters, apart from Chile.
While it is clear that China now has a large influence on the Australian economy, that is not to say that US developments no longer matter. Clearly, they do. They continue to play an important role in shaping financial market behaviour, and household and business sentiment. The point, however, is that over the past 10 to 15 years these channels have not been powerful enough to dominate overall economic outcomes, being outweighed by the other influences I have mentioned.
Switzerland also benefitted from increasing reliance on China
He says China continues to grow and concerns over its slowdown have been proven wrong. Well we never really know. To rely on China for growth is a risky strategy as of now.
He says people are using experiences of 80s and 90s and suggesting RBA will lower rates as US economy decline will put pressure on Aus economy. They made the same mistake in 2003 when Aus economy recovered much quickly:
financial markets seem to have concluded that the risks are weighted towards the Australian economy weakening sharply and, taken literally, seem to be pricing in a reduction in official interest rates towards the unusually low levels reached after the global financial crisis. There are technical reasons why current market pricing may not be giving an accurate picture of interest rate expectations. Nonetheless, markets do seem to have reached a pessimistic assessment and this appears to be based mainly on the assumption that weakness in the US and Europe will flow through to Australia.
The present situation has some similarities to that in 2003. From late 2002 to the third quarter of 2003, financial markets were pricing in cuts in interest rates in Australia, largely on the back of concerns about the sluggishness of the US recovery at that time. In the event, however, that sluggishness in the United States did not flow through to the Australian economy and Australian interest rates did not fall.
Interesting stuff. I think economies should now be worrying over what if China sneezes or develops a bad cough? What are going to be the implications. Financial linkages may not be as strong but trade linkages are. We might again be looking at economics of 1970s when trade linkages mattered more than financial linkages… Anything is possible in the current state of events…