Australia Is Small Change
Banks carrying stacks of debt - much of it bad - have balance sheets teetering on the edge.
To appreciate the magnitude of the economic crisis we have to get our heads around some big numbers - such as the $1.2 trillion (US800 billion) US President Barack Obama is planning to spend to pump up a seriously deflated economy.
How can we make sense of a trillion dollars? Yes, we know it’s a thousand billion or a million million. This is about the size of Australia’s economic activity - our gross domestic product. It is also about a third of the current market value of all houses in Australia, according to latest Reserve bank figures.
The US ecomony is a $A21 trillion creature, so Obama’s package is only 6 per cent of the US economy, or about half the size of the Californian economy (which is twice the size of the entire Australian economy).
If you think these are big numbers, try the figure for “toxic assets” (bad loans) held by the world banking system. These consist of home mortgages and other financial products derived from these mortgages, all of which have collapsed in value as house prices have fallen.
The value of these toxic assets held by European banks alone has been estimated to be as high as $US24 trillion or about 30 times the size of the Australian economy, and nearly twice the size of the entire US economy.
What about bad loans on US banks’ balance sheets? No one really knows their book value. The estimates vary wildly, up to several trillion US dollars - still not nearly as high as the figure on European bank balance sheets.
How did the numbers get so big? How did we get to the point where the scale of the economic crisis and of the rescue packages in the US, Europe and Australia have become so huge?
The wizardry of the world’s bankers allowed the balance sheet of banks (which essentially consist of debts owed to and by the banks), and therefore of businesses and households, to become much too big in relation to the real goods and services underlying the debts.
For example, total bank assets in Australia were $2.7 trillion as at November 2008, which is 2.5 times the size of Australia’s GDP. Like an inverted pyramid, the pointy bit at the bottom is the goods and services (GDP) and the flat top is the balance sheets which eventually can’t be supported and come toppling down.
The toppling down process is deleveraging - banks cut lending which shrinks the size of their balance sheets and the balance sheets of businesses, big and small. Businesses that can’t borrow, can’t invest or build inventories, shrinks demand for goods and services and therefore costs jobs.
The process then feeds on itself until the pyramid is substantially smaller - until balance sheets are a much smaller multiple of economic activity. We’re probably about two-thirds of the way to the end point in that process now.
Do the Chinese have a year of big numbers? This 2008-09 year would be a good candidate. The numbers in 2010 - of assets and debts - will be a good deal smaller.
Small businesses will need to read how I can help them survive this economic crisis here.
