Wednesday, November 17, 2010

Ireland vs Australia

The Europeans are learning a very hard lesson and it is this: you should never lock yourself into macro-economic settings that cannot be altered when conditions change.

That is the central problem confronting the European periphery, they are stuck in a currency that cannot be devalued to improve their competitiveness. Thus they lurch from budget crisis to budget crisis, from bailout to bailout, without ever being able to get their private sectors growing to overcome the debt burden.

The Australian bank debate has a parallel. Currently, there is a near total assumption that we need not address the bank's offshore funding addiction because the Budget will always be there to back them up. This is the implied guarantee that this blogger has discussed before. In the weekend discussion between Alan Kohler and Nicholas Gruen, it was assumed.

There is also a mad campaign to make financial services more competitive by providing a second guarantee, this time explicit, to the securitisation market.

This, in effect, unequivocally and unbreakably yokes the Federal Budget to surpluses or very small deficits ad finitum because it will be insurer for virtually every mortgage in the country.

Such a straightjacket seems ok now, but what happens when things are not so good? Australian households are very indebted. Only a fool would assume that there is no chance of a balance sheet recession in our private sector in the future. If it happens, the government must be in a position to support private deleveraging through deficit spending.

If we move to guarantee the securitisation market, we are worsening a structural prohibition against moderate deficits that threaten sovereign downgrades. So long as the Budget guarantees all those mortgages, a downgrade to it means a downgrade to them (and more expensive servicing).

The real kicker is that if you protect the Budget, then the private sector deleveraging rages unabated and your assets collapse anyway.

Further Budget support for mortgage debt deepens the risk of feedback loops every bit as destructive as the euro currently is to its peripheral states.

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