Sunday, October 19, 2008

Rudd's generosity will exacerbate crisis

Banking failures in New York and even pressures on some Australian banks all seem remote from our own day-to-day lives.

Yet these massive economic convulsions ricochet all the way through the financial system right down to small-business credit availability.

The difficulties that Australia's well-resourced banks have experienced in accessing overseas funds had been causing a crunch in their own lending and credit lines.

Hence the Australian Government's action in explicitly guaranteeing all bank accounts.  Without this, there was a danger of a lending lockdown by banks.

While the guarantee of bank deposits was necessary, the other parts of the Rudd Government's package are likely to backfire and worsen the crisis.

It sounds grand for the Government to inject $10.5 billion into the economy.  But the Government does not actually own that money.  All it has is an ability to take it from some people and give it to others.

Such robbing of Peter to pay Paul brings about adverse effects.  One of these is that it shifts incentives from working to gain income towards lobbying government to supply income by taking funds from others.

Moreover, the $10.5 billion funding measures are targeted at those who are likely to spend the money on consumption -- on houses for young people and on everyday goods for pensioners and carers.

Gifting $10.5 billion to these recipients, no matter how worthy they are, means we are switching resources from savings to consumption.

And, together with the Reserve Bank's reckless credit expansion, the underlying cause of Australia's present problems is inadequate domestic saving.

This required excessive overseas borrowing, which has now dried up.  And yet the Government is now also spending domestic savings.

Meanwhile, the financial meltdown is becoming an economic recession, which increased government spending could easily exacerbate.

Within a few months, Canberra will realise that its $10.5 billion package has failed to reignite the economy.  Hopefully it won't introduce an even bigger package since this will further undermine the nation's savings and investment.

It's an accumulation of things that make for a recession.  People stop spending.  This is not because they suddenly don't need goods and services.  Nor is it that they cannot afford them, though increased unemployment will necessitate some belt-tightening.

The fact is that people have recognised that their savings are less valuable than they thought they were.  Their super fund is down or the value of their investment property is looking softer.

For some, their annual bonus is looking less certain, while others may be fearful of losing their jobs.

Those in businesses selling or using imported goods have seen the Aussie dollar's crash increase their costs by 20 per cent and such increases are difficult to pass on.

This lower level of wealth -- actual and prospective -- means most of us will be looking to do more saving and less spending.  The upshot is fewer customers in cafes, furniture stores, car dealers and other areas where we can delay purchases.

Anything the Government tries to do to offset lower consumer spending at this late stage will only worsen things.  The focus must instead be on cutting its own waste.


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