A week ago, Nomura’s Richard Koo wrote a report about the Eurozone’s crisis and its consequence to other countries, like Australia. He was surprised by the degree of caution expressed by local investors there, citing weak loan demand in most parts of the economy, and a substantial increase in savings not seen since 2008 by both household and corporate sector.

His comments:

“Some are also arguing that Australia, where incomes are lower than in the US but average house prices are much higher, is in the midst of a bubble. Such concerns have been amplified by a nascent decline in house prices in many cities. Adding to worries is the recent slowdown in China, Australia’s leading export market. The Australian manufacturing sector has already been hurt by a strong currency, the result of robust mineral exports and high interest rates, and a drop in mineral exports to China could trigger a broad-based economic deceleration.

Australia also pursuing austerity despite weak private loan demand
“On the policy front, prime minister Julia Gillard’s bid to bring the federal budget into surplus with higher taxes in spite of a decline in private loan demand could weigh further on the economy. Australia was one of the first countries to implement fiscal stimulus and stem the economic weakness triggered by the Lehman inspired financial crisis. But now the policy debate appears to be shifting in favor of fiscal consolidation—in part because of the events in Greece. It is often said that the person who prevents a crisis is never lauded as a hero.”

Australian banks’ overseas funding one source of concern
“Others argue that while Australian house prices may have begun to slip, large capital inflows from Asia—and particularly from China and Korea—ensure the nation’s housing market will not experience a US-like crash. In the US, where houses listed at $5,000 remain unsold in a city like Detroit, there are also places like San Francisco where robust immigration from Asia has helped support property prices. Australian homebuyers are also unable to take out a mortgage without a down payment, as was common in the US during the bubble: local banks generally require 20% down. And unlike the situation in many US states, where homeowners are able to “return the keys” and tear up their mortgages if the house’s value falls below the outstanding amount of their mortgage, giving up the house in Australia—as in Japan— does not free homeowners from the obligation to pay back the mortgage. This lends support to the argument that housing market weakness is unlikely to snowball as it did in the US.

On the other hand, loans extended by Australian banks exceed deposits, forcing them to rely heavily on overseas funding. Funding costs could increase substantially if overseas lenders began to worry about an economic slowdown or a fall in house prices in Australia. European banks are already pulling back from their global operations, raising concerns about the continued ability of Australian banks to obtain funding. This concern has led to greater caution amongst the Australian banks themselves. In any event, the Australian economy remains a target of envy for the US, Japan, and Europe, but the economy could still experience conditions resembling a balance sheet recession if contractionary fiscal policy were to overlap with a housing market correction.

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