Synchronised G3 recession now in prospect

The November World Risk Developments newsletter of Australia’s export credit agency (EFIC) – released today – says a synchronised G3 recession is in prospect, as the credit crisis hits business and consumer spending, though growth could still hold up quite well in Asia and the Gulf.

World Risk Developments November 2008 Highlights

• Credit Crisis hits mining
• Back to the 1930s? Unlikely
• Gulf states to weather financial storm

Credit crisis hits mining

EFIC’s Chief Economist, Roger Donnelly says that reduced availability of debt and equity capital and lower commodity prices are forcing – or persuading – mine promoters to postpone projects.

“Investment bank Credit Suisse reportedly said on 27 October that the credit crisis could delay around US$50 billion of worldwide investment in new mines and mine expansions planned for 2009.”

The limited access to financing may delay for 2-3 years construction of some 300 million tons of iron ore capacity, 5 million tons of copper, 10 million tons of aluminium, and more than 1 million ounces of platinum.

“Following the recent slump in commodity prices some miners are deciding to leave resources in the ground till prices recover – even those that can still tap the debt and equity markets.  So the retrenchment could be large.  It certainly represents a major change from even two months ago when most announcements  from companies were still bullish,” says Donnelly. 

Back to the 1930s?  Unlikely

There has been much talk recently that the world economy is ‘going back to the 1930s’. “How close are we to a 1929-like Financial Crash and 1930s-style Great Depression?” ask Donnelly. “Two points are worth noting.”

“It is difficult to exaggerate the severity of the recent panic and recent events certainly seem to have been on a scale resembling the 1930s.”

“But in the 1930s, central banks stood idly by as depositors rushed to withdraw their money and banks called in loans.  The central banks mistakenly thought that this was a healthy ‘purge’ after the ‘binge’ of the Roaring Twenties.” 

In fact, what happened was the stock of money and credit collapsed, and deflation set in, forcing highly geared borrowers to default in repeated waves (a virulent process economists call ‘debt deflation’). 

Central banks and treasuries have learnt that to head off such a disaster they mustn't be complacent.  So this time, they are taking decisive steps to ensure money, credit – and aggregate demand – don't collapse.

However, Donnelly warns: “There remains a risk that the panic doesn't subside and central banks and treasuries finally ‘use up all of their ammunition’ – interest rate cuts, borrowing capacity etc – to fight it. In which case, the world economy could succumb to a Great Depression.  But that still seems to be a small risk.”

“The bigger risk is that the world economy will now perform only sluggishly for a protracted period, as bank and non-bank firms alike continue to de-gear and recapitalise.”

 “A synchronised G3 recession is in prospect, though growth could still hold up quite well in Asia and the Gulf.  In these more difficult conditions, fragile and vulnerable entities, be they countries, governments, banks or companies, could collapse, though they may be rescued by the state if deemed Too Big or Too Important to fail.”

Gulf states to weather financial storm

Credit, trade and oil price shocks are hitting the Gulf hard, but governments will deploy their petro-wealth to cushion the impact.  The result: slower growth, but no financial crisis, says Donnelly.

“Both the UAE and Kuwait have had to confront the same interbank lending freeze and capital adequacy issues in their banking systems that the G3 economies are grappling with,” says Donnelly.

“And, like the G3 they have been providing financial support to shore up liquidity, capital and confidence.”

On the trade front, the shocks go beyond just the slump in oil prices, because in recent years Gulf states have been using their petrodollars to diversify into tourism, real estate development, financial services, petrochemicals and energy-intensive industries such as aluminium smelting.  "All of these industries now face considerably more gloomy outlooks as a result of the credit crisis and world economic slowdown", notes Donnelly.