varanus& the global credit crunch: the impact of …...2008/11/12 · varanus& the global...

Varanus & the global credit crunch: the impact of two crises on the

Australian economy

Presentation to a CEDA conference

Perth Convention Exhibition Centre12th November 2008

Saul EslakeChief Economist, ANZ

2The Varanus Island explosion has had a material economic effect, though this has been mitigated by use of alternate energy sources

� The 3 June explosion at Apache Energy’s Varanus Island gas processing facility resulted in the loss of around 350TJ (30% of the WA’s total gas supply)

� Primary impacts have been on businesses supplied by Varanus Island gas (mostly in the mining and manufacturing sectors), which have faced reduced gas supplies and higher energy costs - residential supplies have been unaffected.

� Partial gas supply from Varanus Island resumed in early August, ramping up to 2/3 supply by mid-August. Full production is expected by the end of 2008.

� The shortfall in WA’s energy supplies has been mitigated by the use of alternate gas and other energy sources

─ North West Shelf production has been increased by 150TJ above normal

─ repairs and planned maintenance of coal power stations was expedited to bring them back online, while three retired power stations have been temporarily reinstated

─ there has been some substitution to diesel fuel as a source of power generation

� WA Treasury estimates that the total cost of the gas supply disruption will be around $2bn spread over the June and September quarters of 2008

─ GSP and consumption growth will be ½ pc pt lower, employment growth ¾ pc pt lower, and exports growth 1¼ pc pt lower than otherwise

� The disruption has reduced national GDP growth by around ¼ pc pt over the June and September quarters

3The economic impact of the Varanus Island has been less ‘visible than Longford, but will end up being at least as costly

� The explosion at the Esso gas facility at Longford in 1998 had significant human, social and economic costs

– 2 people were killed in the explosions

– Longford provided 98% of Victoria’s gas ─ with gas the primary energy source for 80% of Victorian households, 50% of commercial enterprises and 25% of industry

– 4mn consumers were left without gas for 19 days, while a further 89,000 businesses were similarly affected

� a Royal Commission established to investigate the causes and consequences of the Longford explosion estimated the cost to Victoria’s economy at $1.3bn (around 0.8% of gross State product t that year)

� The Varanus Island explosion has been somewhat less visible to the average person than Longford, since the bulk of the disruption has been borne by business.

� However Varanus is likely to be at least as costly in economic terms as Longford:

─ around 1/3 of businesses have been affected by energy supply disruptions and/or higher energy costs (although residential supplies and 2/3 of businesses not supplied by Varanus Island gas have been largely unaffected)

─ the economic cost has been mitigated by the use of alternative energy sources, with the bulk of the energy shortfall experienced over two months over June and July

4The current global financial crisis stems from the bursting of a‘credit market bubble’

From bubble …

Cheap andeasy money

Increased appetite for risk

Increased capacity for leverage

New forms of

‘financialengineering’

Rising asset prices

To bust ….

Falling asset prices

Reduced appetite for risk

Distrust of new forms of finance

Slowing economy

Reduced capacity for leverage

5For a time, low interest rates and the explosion in ‘sub-prime’lending created boom conditions in the US housing market

Mortgage applications

US housing market indicators up to 2005

Sources: Mortgage Bankers’ Association of America; US Commerce Department.

Mortgage interest rates

Home ownership rate

0

1

2

3

4

5

6

7

8

01 02 03 04 05 06 07 08

% pa

30-year fixed rate

Adjustable-rate

'Fed funds'

(cash) rate

90

100

110

120

130

140

150

160

170

01 02 03 04 05 06 07 08

Index (Jan-Dec

2000 = 100)

Actual

Trend

67.0

67.5

68.0

68.5

69.0

69.5

01 02 03 04 05 06 07 08

% of households

Housing starts

0.8

1.0

1.2

1.4

1.6

1.8

2.0

2.2

01 02 03 04 05 06 07 08

Mns (annual rate)

Actual

Trend

6

But eventually the bubble burst, as bubbles always do

Mortgage applications

US housing market indicators up to 2008

Sources: Mortgage Bankers’ Association of America; US Commerce Department.

Mortgage interest rates

Home ownership rate

0

1

2

3

4

5

6

7

8

01 02 03 04 05 06 07 08

% pa 30-year fixed rate

Adjustable-rate

'Fed funds'

(cash) rate

90

100

110

120

130

140

150

160

170

01 02 03 04 05 06 07 08

Index (Jan-Dec

2000 = 100)

ActualTrend

67.0

67.5

68.0

68.5

69.0

69.5

01 02 03 04 05 06 07 08

% of households

Housing starts

0.8

1.0

1.2

1.4

1.6

1.8

2.0

2.2

01 02 03 04 05 06 07 08

Mns (annual rate)

ActualTrend

7Excess supply of housing as a result of rising defaults and foreclosures is putting sustained downward pressure on prices

Existing houses for sale

US housing market indicators

Sources: US National Association of Realtors; Commerce Department; S&P (the Case-Shiller index).

Existing home prices

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

01 02 03 04 05 06 07 08

Mns

100

120

140

160

180

200

220

240

01 02 03 04 05 06 07 08

Jan 2000 = 100

Down 22%

from peak

Existing home sales

4.0

4.5

5.0

5.5

6.0

6.5

01 02 03 04 05 06 07 08

Mns (annual rate)

Housing affordability

100

105

110

115

120

125

130

135

140

01 02 03 04 05 06 07 08

Index

8The US mortgage market meltdown has prompted a tidal wave of losses and write-downs by banks around the world

Losses & write-downs announced since mid-2007

180.0Other institutions*

678.1Total banks

9.6Canadian banks

420.5US banks

220.7European banks

27.3Asian and other banks

Total (US$ bn)

Country of origin

US mortgage delinquencies

0

5

10

15

20

00 01 02 03 04 05 06 07 08

% of mortgages outstanding

90 days or more in arrearsSub-prime

Prime

ABX index of prices of US mortgage-backed securities

0

20

40

60

80

100

Dec-06

Mar-07

Jun-07

Sep-07

Dec-07

Mar-08

Jun-08

Sep-08

Dec-08

AAA rated

AA ratedBBB- rated

* ‘Other institutions’ include insurance companies, pension funds and hedge funds. Sources: US Mortgage Bankers’ Association; IMF; Bloomberg; ANZ Economics & Markets Research.

Capital raised by banks since mid-2007

672.3Total

3.1Canadian

351.2US

284.8European

288.5of which, from governments

33.2Asian and other

Total (US$ bn)

Country of origin

9

United States

Measures announced by governments since mid-October are slowly working to ease financial market stress

Euro area

Note: The 3-mth overnight index swap (OIS) rate shows market expectations of the average official cash rate overthe following three months. Source: Bloomberg.

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

Dec-06 Jun-07 Dec-07 Jun-08 Dec-08

% pa

3-mth inter-

bank rate

3-mth overnight

index swap rate

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0


% pa3-mth inter-

bank rate

3-mth overnight

index swap rate

United Kingdom

3.0

3.5

4.0

4.55.0

5.5

6.0

6.5

7.0


% pa 3-mth inter-

bank rate

3-mth overnight

index swap rate

Australia

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0


% pa 3-mth

bank

bill

swap

rate

3-mth overnight

index swap rate

3-month inter-bank borrowing rates and official cash rates

10Banks in the US and the euro area are tightening credit standards

US banks

-40

-20

0

20

40

60

80

100

00 01 02 03 04 05 06 07 08

Net balance tightening standards (%)

Large

Small

Commercial & industrial loans

Mortgage and consumer loans

-20

0

20

40

60

80

00 01 02 03 04 05 06 07 08


Mortgage*Consumer

Euro area banks

-20

0

20

40

60

00 01 02 03 04 05 06 07 08


Loans to enterprises

Mortgage and consumer loans

-10

0

10

20

30

40

00 01 02 03 04 05 06 07 08

Net balance tightening standards (%)House

purchase

Consumer

* Weighted average of prime & sub-prime after June 2007Sources: US Federal Reserve and European Central Bank surveys of loan officers.

11

Capitalization of world equity markets

Investors around the world have lost US$23.2 trillion since the end of October 2007

Source: Datastream.

15

20

25

30

35

40

45

50

55

2000 2001 2002 2003 2004 2005 2006 2007 2008

US$ trillion

Peak-to-trough

decline from

31 Oct 2007:

US$27.6 trn

(46% of 2007

world GDP)

12Many indicators suggest that the US economy is heading for, or already in, recession

Selected US indicators

Note: shaded periods denote recessions as designated by National Bureau of Economic Research.Sources: The Conference Board; Bureau of Labor Statistics; Census Bureau.

40

60

80

100

120

140

160

80 84 88 92 96 00 04 08

1985 = 100 (trend)

Consumer confidence

4

5

6

7

8

9

10

11

80 84 88 92 96 00 04 08

% of labour force (trend)

Unemployment

8

10

12

14

16

18

20

80 84 88 92 96 00 04 08

Mns (annual rate; trend)

Motor vehicle sales

0.8

1.0

1.2

1.4

1.6

1.8

2.0

2.2

80 84 88 92 96 00 04 08

Mns (annual rate; trend)

Housing starts

13

-2

-1

0

1

2

3

4

5

6

7

8

00 01 02 03 04 05 06 07 08 09

% change from previous quarter

(seas. adj. annualized rate)

The US hasn’t experienced consecutive quarters of negative GDP growth – but is likely to in the current half year

US real GDP growth

Source: US Bureau of Economic Analysis. Shaded area denotes 2001 recession as designated byNational Bureau of Economic Research.

Note: 2001 recessiondid not feature successivecontractions in real GDP

14European economies are also experiencing an economic downturn with falling house prices and rising unemployment

Euro area

Business & consumer confidence

Unemployment

Sources: European Commission; Eurostat; Confederation of British Industry; UK Office of National Statistics (note UK unemployment measure based on claimant count).

7.0

7.5

8.0

8.5

9.0

9.5

01 02 03 04 05 06 07 08

%

UK

Unemployment

4.0

4.5

5.0

5.5

6.0

01 02 03 04 05 06 07 08

%

-25

-20

-15

-10

-5

0

5

10

01 02 03 04 05 06 07 08

Net balance (%)Business

Consumer

Business & consumer confidence

-60-50-40-30-20-1001020

01 02 03 04 05 06 07 08

Net balance (%)

Business

Consumer

15Japan’s economy has slowed sharply even though its banks have very little exposure to the global credit crisis

Business confidence

Consumer confidence

Sources: European Commission; Eurostat; Bank of Japan; Japan Economic & Social Research Institute; Japan Home Ministry.

Japan

Unemployment

3.5

4.0

4.5

5.0

5.5

01 02 03 04 05 06 07 08

%

Actual

Trend

Export volumes

-15

-10

-5

0

5

10

15

20

01 02 03 04 05 06 07 08

Net balance (%)

Trend

Actual

-60

-40

-20

0

20

40

01 02 03 04 05 06 07 08

Net balance (%) reporting

'better business conditions'Large companies

Small companies

30

35

40

45

50

55

01 02 03 04 05 06 07 08

% optimisticTokyo

All Japan

16

6

7

8

9

10

11

12

13

01 02 03 04 05 06 07 08

% change from year earlier

Slowest growth

rate since SARS

(2003)

China’s economy is slowing, reflecting slower export growth and an internal property slump

Chinese economic indicators

Real GDP growth

Industrial production

Source: China National Statistics Bureau; ANZ.

6

8

10

12

14

16

18

20

01 02 03 04 05 06 07 08


(6-mth moving avge)

Real estate prices

Exports

0

10

20

30

40

01 02 03 04 05 06 07 08


(6-mth moving avge)

(deflated by change in

export price index)

-4-2024681012

01 02 03 04 05 06 07 08


17

0

1

2

3

4

5

6

7

8

70 75 80 85 90 95 00 05 10

Real % change from year earlier

"Global

recession"

threshhold

Note: GDP is measured in US$ at purchasing power parities.Source: IMF World Economic Outlook October 2008; ANZ Economics & Markets Research.

Global economic growth

Global growth will weaken sharply with 2009 looking like the worst year for ‘advanced’ economies since the 1930s

-1

0

1

2

3

4

5

6

7

8

9

70 75 80 85 90 95 00 05 10

Real % change from year earlier

'Advanced' economies

'Developing'

economies

18

Oil Gold

Wheat

Commodity prices have fallen reflecting declining demand, the unwinding of speculative trades and a stronger US dollar

50

75

100

125

150


US$ per barrel

Base metals

Sources: Bloomberg; Datastream.

200

250

300

350

400

450

500


Index: 2 Jan 1996 = 100

600

650

700

750800

850

900

950

1000


US$ per oz.

200

300

400

500

600

700


US$/tonne

19Spot prices for Australia’s two largest commodity exports have fallen sharply in recent weeks and are likely to decline further

Coal prices

Sources: Datastream; Bloomberg; ANZ Economics & Markets Research.

Bulk commodity shipping costs

Iron ore prices

0

50

100

150

200

01 02 03 04 05 06 07 08

US$ per tonneSpot

(Indian)

Contract price

0

50

100

150

200

01 02 03 04 05 06 07 08

US$ per tonne

(thermal coal)Spot price

(ex-Newcastle)

Contract

price

0

5

10

15

20

01 02 03 04 05 06 07 08

x 1000

'Baltic freight

(cape size)

futures index

20

-2

-1

0

1

2

3

4

5

6

7

8

01 02 03 04 05 06 07 08 09

Real % change from

year earlier

Real gross

domestic

product (GDP)

70

80

90

100

110

120

130

01 02 03 04 05 06 07 08 09

2005-06 = 100

A sharp fall in commodity prices will reverse the contribution which rising terms of trade have made to Australia’s income

Australia’s terms of trade(ratio of export to import prices)

Note: real gross domestic income (GDI) is real GDP adjusted for changes in the terms of trade; it measures the ‘purchasing power’ of the income associated with producing the GDP. Sources: ABS; ANZ.

Real gross domestic income (GDI) and product (GDP)

21But Australia is exposed to the global credit crunch because of our large external deficit and the way we finance it

Sources: IMF World Economic Outlook (October 2008); ABS; ANZ. Note that apparently large movements in ‘other (incl. reserves) in 2007-08 largely reflect the withdrawal of cash deposits at the RBA by the Future Fund; the RBA had invested these largely in US Treasuries, and they were reported as part of the RBA’s official reserve assets.

Financing Australia’s current account deficit

-50

-25

0

25

50

75

100

125

00 01 02 03 04 05 06 07 08

Net equity Banks' net borrowing

Other net borrowing Other (incl. reserves)

A$ bn - 4-qtr moving total

Current account deficit

Methods of financing

Current account deficits2008

0

25

50

75

100

125

150

175

200

225

US

Spain*

UK

France*

Italy*

Austra

lia

Greece*

Turkey

India

Portu

gal*

Romania

Brazil

Poland

Sth Afric

a

Mexico

US$ bn

US$664bn

* member of euro area

(deficit financed out of

Germany's surplus)

22

Banks’ short-term funding costs Corporate bond yield spreads

Bank share prices

Australian financial markets have come under similar pressures to their overseas counterparts, though these are now easing

Banks’ long-term funding costs

0

25

50

75

100

125

150


5-year swap spread (bp)

40

50

60

7080

90

100

110

120


31 Dec 2006 = 100

Note: all data shown as 5-day moving averages. Sources: Bloomberg; Datastream.

0

20

40

60

80

100

120


90-day Libor spread

over OIS (bp)

0

50

100

150

200

250

300


AA spread over 5-7 yr

gov't bond yields (bp)

23Consumer and business confidence have fallen sharply this year although both now seem to be stabilizing (for now, anyway)

Consumer confidence

Sources: Roy Morgan Research; National Australia Bank; ANZ

Business confidence

80

90

100

110

120

130

140

90 93 96 99 02 05 08

Ratio of optimists

to pessimists (%)

Actual

Trend

-30

-20

-10

0

10

20

30

40

90 93 96 99 02 05 08

Net balance of optimists

minus pessimists (%)

Actual

Trend

24Household spending and borrowing, and housing activity, have both slowed sharply over the past six months

Retail sales

Sources: ABS; ANZ Economics & Markets Research.

0

2

4

6

8

10

02 03 04 05 06 07 08


Actual

Trend

Motor vehicle sales

-10

-5

0

5

10

15

02 03 04 05 06 07 08


Actual

Trend

Housing finance commitments

-30

-15

0

15

30

45

60

02 03 04 05 06 07 08


ActualTrend

Residential building approvals

-20

-15

-10

-5

0

5

10

15

20

02 03 04 05 06 07 08


Actual

Trend

25

0

2

4

6

8

72 76 80 84 88 92 96 00 04 08

Ratio of gross operating surplus of

corporate trading enterprises to

interest paid

The corporate sector is (in general) in a strong financial position and shouldn’t need to cut labour costs aggressively

Australian non-financial corporate sector finances

Debt-equity ratio

Interest cover ratio

Note: Shaded areas denoted recessions.Sources: Australian Bureau of Statistics; Reserve Bank of Australia; ANZ.

50

75

100

125

150

175

88 92 96 00 04 08

%

Real unit labour costs

-6

-4

-2

0

2

4

6

8

72 76 80 84 88 92 96 00 04 08

% change from year earlier (trend)

‘Profit share’ of national income

15

20

25

30

72 76 80 84 88 92 96 00 04 08

Gross operating surplus of

corporate trading enterprises

(as a % of GDP)

26Australia’s housing market has clearly softened but is unlikely to become as dire as America’s

-20-15-10

-50510

1520

01 02 03 04 05 06 07 08

% change from year earlierAustralia

US

House prices

* 90 days or more past due. For Australia, securitized mortgages only (including on-balance sheet mortgages would result in a lower figure). Sources: ABS; US Commerce Department; S&P; Mortgage Bankers’Association of America.

Mortgage delinquency rates*

0

1

2

3

4

5

01 02 03 04 05 06 07 08

% of total loans outstanding

Australia

US

0.0

0.5

1.0

1.5

2.0

01 02 03 04 05 06 07 08


Australia

US

Population growth

50

75

100

125

150

175

01 02 03 04 05 06 07 08

1990s average = 100

Australia

US

Housing commencements

27

3.0

4.0

5.0

6.0

7.0

8.0

9.0

01 02 03 04 05 06 07 08 09 10

% pa

RBA official

cash rate

90-day

bank bill yield

The official cash rate will probably fall to a new low as the RBA seeks to counter the risk of recession

Short-term interest rates � The Reserve Bank has now cut its official cash rate by 2% in just two months (it took almost three years for them to raise it by as much)

� The larger-than-expected movements in October and November underscore the RBA’s capacity to respond decisively to deteriorating economic conditions and its willingness to do so

� Although inflation remains well above the 2-3% target the RBA is explicitly judging that lower commodity prices and weaker economic activity will reduce the inflation risk

� Significantly, this week’s post-Board meeting statement did not include any reference to the larger-than-expected move not setting a precedent for future meetings

� It now looks likely that the cash rate will fall below the previous trough of 4¼%

Sources: Thomson Financial; ANZ.

28Australia is also very well-placed to use fiscal policy (tax cuts and government spending) to support economic activity

Note: data shown are for the ‘general government’ sector, ie including State and local governments but excluding government business enterprises. Source: OECD, Economic Outlook 83, June 2008,

Budget surplus/deficit, 2008

-6

-4

-2

0

2

4

6

Korea

Sweden

Austra

lia

Spain

Canada

Germ

any

Japan

Italy

France

UK

US

% of GDP

Government net debt, 2008

-60

-40

-20

0

20

40

60

80

100

Korea

Sweden

Austra

lia

Spain

Canada

UK

France

Germ

any

US

Japan

Italy

% of GDP

29

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

01 02 03 04 05 06 07 08 09

2

3

4

5

6

7

8% change from

year earlier

Unemployment

(right scale)

Employment

(left scale)

%

-2

-1

0

1

2

3

4

5

6

7

8

01 02 03 04 05 06 07 08 09

Real % change from

year earlier

GDP

(output)

Domestic final

demand (spending)

The economy will slow sharply (although it won’t contract outright) and unemployment will rise by around 1½ pc pts

Spending and output

Sources: Australian Bureau of Statistics; ANZ.

Employment and unemployment

30

A$ vs US$ and US$ vs other major currencies

The recent sharp drop in the A$ is partly a reflection of the rebound in the US$ …

Source: US Federal Reserve Board; Datastream.

0.45

0.50

0.55

0.60

0.65

0.70

0.75

0.80

0.85

0.90

0.95

1.00

2000 2001 2002 2003 2004 2005 2006 2007 2008

65

70

75

80

85

90

95

100

105

110

115

Mar 1973 = 100US$ per A$

Australian dollar

vs US dollar

(left scale)

Trade-weighted index of US$

vs other major currencies

(right scale, inverted)

31

US dollar vs euro US dollar trade weighted index(major currencies)

US dollar vs yuan

The US$ has risen against most currencies (other than the yen) in recent weeks because banks are hoarding dollars

1.20

1.30

1.40

1.50

1.60


US$ per € (inverted scale)

US dollar vs yen

Source: Datastream.

90

95

100

105

110

115

120

125


¥ per US$

68707274767880828486


Mar 1973 = 100

6.25

6.50

6.75

7.00

7.25

7.50

7.75

8.00


Yuan per US$

12-mth NDF

(non-deliverable

forward) rate

32

A$ vs US$ andcommodity prices

The A$’s decline also reflects plummeting commodity prices and the narrowing Australian-US interest rate spread

Source: US Federal Reserve Board; Datastream.

0.45

0.50

0.55

0.60

0.65

0.70

0.75

0.80

0.85

0.90

0.95

1.00

00 01 02 03 04 05 06 07 08

100

150

200

250

300

350

400

450

500

550

6001966 = 100US$ per A$

Australian dollar

vs US dollar

(left scale)

CRB index of industrial

commodity prices

(right scale)

A$ vs US$ and Australia-USinterest rate spreads

0.45

0.50

0.55

0.60

0.65

0.70

0.75

0.80

0.85

0.90

0.95

1.00

00 01 02 03 04 05 06 07 08

-100

0

100

200

300

400

500

600Basis pointsUS$ per A$

Australian dollar

vs US dollar (left scale)

Spread between

Australian & US

2-yr swap rates

(right scale)

33

0.50

0.55

0.60

0.65

0.70

0.75

0.80

0.85

0.90

0.95

1.00

01 02 03 04 05 06 07 08 09 10

US$ per A$

A$ likely to mirror US$ fluctuations in the near term but to trend towards the low US70’s over the next two years

A$ vs US$� In the near term, A$ likely to trade in a

US80-86¢ range mirroring fluctuations in the US$ against other major currencies

─ a slump in the US$ triggered by renewed financial strains (or uncertainty as to how they will be dealt with) could see the A$ closer to US90¢ again

� Beyond the near term, the A$ is likely to be pulled down by two factors:

– a narrowing of the interest rate spread between Australia and the US (from ~450bp at 90 days currently to less than 200bp by mid-2010)

– declining commodity prices (we expect a drop of ~20-25% in the RBA index in US$ terms by mid-2010)

� These considerations point to the A$ declining to a low of ~US60¢ by late 2009 or early 2010

Sources: Thomson Financial; ANZ.

34

Summary

� The world is confronting an extremely serious financial crisis– it is no longer a ‘sub-prime mortgage crisis’, or even solely a US financial crisis, but a global financial crisis

– however the measures announced in mid-October should, over time, prove effective in stemming the financial crisis

� There is now a high probability that a global recession is under way, with growth in the world economy falling to about 2½% next year– industrial countries as a group will experience negative growth for the first time since the 1930s

– developing country growth will slow to about 5%, from 7-8% pa during the past four years

� Australia’s economy is also slowing significantly, and unemployment will rise by nearly 2 pc pts from here, although the odds are good that Australia will avoid consecutive quarters of negative growth─ Australia’s financial system is more robust than that of most other Western countries

─ Australia will continue to benefit from developing country growth, albeit less so than previously expected

─ Australia has more scope to deploy economic policy instruments to support growth, and has already demonstrated its willingness to use them in a timely fashion

─ whether Australia experiences negative growth may depend on whether employers embark on across-the-board headcount reductions

� The RBA cash rate will fall to 3½% by Easter next year

� The A$ in an environment of global recession the currency is likely to settle in the mid- or even low US60s

35

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