Monday, 13 October 2008

Testing Times for the Clever Country

I guess not many people knew that bank deposits in Australia have hitherto not been guaranteed, until the government announced that they would now be. The other marvel, of course, is that when a guarantee exists, it will probably not be resorted to. The government's statement is purely to shore up confidence in the financial system and prevent a run on the banks.

Of course, there's the fine print. The Australian government will only guarantee deposits in Australian-incorporated banks, so we could still see a run on foreign-owned banks like Citi and HSBC. Still, it's a much-needed affirmation from the government, and will do much to keep the financial system on its feet.

I guess we're entering a phase when the "Australian model" is going to be put to the test like never before. Prime Minister Kevin Rudd has said he doesn't consider the budget surplus as something to defend in its own right. He's willing to use up the surplus if that's what it takes to stimulate the economy and prevent a deep recession.

Quotable quote: "How long have you all heard me say it is good to have a surplus ... as a buffer for the future? Well, the future is here."

The biggest fears now are a slowdown in growth and a rise in unemployment. The Reserve Bank has done its bit to stimulate growth by slashing interest rates by a full percent, something normally unheard of. The upside of having had high interest rates in the recent past is that there's sufficient leeway to move rates down, a luxury that the US doesn't have. If the PM and his Treasurer Wayne Swan play their cards right by operating the right fiscal levers (and they can spend a fair bit without running up a budget deficit, unlike the US government, which has dug itself into a deeper deficit hole), they can keep the Australian miracle going, and in the process, ensure their own places in history.

It's a difficult time in world history and no time to be partisan, but if Australia comes out of this crisis in better shape than other nations, it will be a powerful lesson in the benefits of good economic governance. I.e., avoid a budget deficit at all costs and tweak interest rates constantly to encourage growth without provoking inflation higher than 2-3%. (And let me add my Liquidism mantra like a broken record: maintain high levels of market liquidity through aggressive antitrust if need be. A thousand blades of grass will weather a storm better than a few oak trees.)

The Australian financial sector has also been prudently regulated and the "toxic assets" of other economies haven't been ingested to any significant degree here. To some extent, this hides the problem of oligopolistic conditions in the market. I wonder if we will have to wait for a different crisis before we learn that lesson...

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