BHP Billiton chairman Don Argus has injected a chilling reality check for those who believe that the worst of the global financial crisis may be over.
In an important speech in Brisbane, Argus made it very clear that he sees, at best, a very protracted and risk-laden period ahead as the world grapples with the legacies of the credit bubble and bust. He also sees some very specific and rather daunting challenges for the Australian system and economy.
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Argus’s comments carry extra import, not only because he is chairman of the world’s biggest resources group but also because of his very lengthy executive career in banking, which culminated in a lengthy and highly successful era as chief executive of National Australia Bank. He has a senior insider’s understanding of banks and the global financial system.
He sees no short-term solutions to the issues facing the global and Australian economies. Any recovery is likely to be complex and protracted. When the recovery comes, the world will be a fundamentally different place to do business. The debts being incurred by governments, businesses and communities in an effort to respond to the crisis and global recession will be a long-term burden.
Argus is pessimistic about the prospects of a short-term economic recovery, citing the scale of losses by banks and other financial institutions; and the debts they and the governments trying to repair the damage done to the financial system will incur.
The IMF recently forecast write-downs within financial institutions as a result of the crisis of $US4 trillion. Argus focuses on the fact that governments have already injected about $US8.9 trillion into their banking systems – but that this was less than a third of the banks’ funding needs.
What that means, he says, is that major economies will be in debt for a long time. Average debt-to-GDP ratios for the major developed economies will blow out to more than 100%. The balance sheets of many banks will have to shrink and be repaired. Credit will be reduced even before one takes into account the demise of securitised lending.
His conclusion is that the global recession will be long and the recovery period protracted, with the potential for further down-side surprises.
The Australian dimension of the crisis relates to our historic reliance on foreign capital and the structural reliance of our economy on large-scale capital-intensive industries like mining. There were estimates, he said, that we would need to fund $210 billion of large-scale projects over the next five years and refinance $108 billion of debt in the next two years.
The domestic banks, which aren’t big by global standards, are becoming selective about the sectors they lend to; our savings rate is low; and foreign lenders are retreating to their home markets.
There is a risk that total credit supply growth to the non-financial sector falls sharply and turns negative. The risk would be particularly threatening to large-scale projects, which traditionally have relied heavily on foreign lenders and debt markets for funding.
There is going to be a lot of competition for funding from governments, banks and corporates in a post-crisis world where the supply of credit will be much more limited, which is one of the major reasons Argus thinks the post-crisis settings will be very different to the ones we’ve be used to.
Argus’s gloomy view of the global economic outlook is consistent with the more pragmatic assessments of just how deep a mess the developed world is in and how difficult it is going to be to unwind the desperate measures government and institutions have been forced to implement in response to the crisis.
One wouldn’t expect an early or easy recovery from the worst financial crisis since the Great Depression. The legacy issues from the crisis and global recession that will have to be managed and unwound are going to be extraordinary in scale, complexity and sensitivity, and there may have to be some restructuring of the domestic financial system to respond to them. Argus, for instance, believes we are going to have to develop a large and liquid corporate bond market.
Argus not only spells out the threats and their implications in some detail, with a veteran banker’s understanding, but has highlighted some issues for this economy that haven’t had much if any visibility.
It may make for depressing reading, but it provides a sobering counterpoint to some of the more complacent voices that have emerged in tandem with the rebound in equity markets and gradual reopening of credit markets.
This first appeared on Business Spectator.