Where are we in the downturn cycle?

One of the big questions we are getting asked here at SmartCompany is: What stage of the downturn are we at?

It’s a tough question to answer and the range of opinions is huge, with economists predicting everything from a depression with 20% unemployment, to a prolonged recession, to a mild slowdown.

In order to give entrepreneurs a bit of an idea of where we are in the downturn cycle and how bad things might become, we thought we’d take a look at some of the possible scenarios in one of our famous Q&As.

Another night, another rescue package for the financial system. What happened overnight with this central co-ordinated central bank action?

The world’s central banks used the biggest weapon at their disposal last night – interest rates – in an attempt to unfreeze credit markets. The US Federal Reserve, the European Central Bank, the Bank of England and the central banks of Canada and Sweden all cut their official interest rates by 0.5%, with China also dropping its one-year interest rate by 0.27%.

The hope is that this co-ordinated emergency action will encourage banks to start lending to each other, households and businesses once again. In many ways, the rate cuts aren’t the important thing – the fact that all these banks took action together is really the thing that should help restore the confidence of investors.

The International Monetary Fund came out with some data showing that Australia was going to keep growing next year. That’s good isn’t it?

It’s certainly not bad. The IMF’s World Economic Outlook report showed that Australia’s economy will grow by 2.2% next year, compared with growth of 0.1% in the US, 0.2% in the Euro zone and -0.1% in Britain. Australia’s good growth figures are underwritten by China, which is expected to grow by 9.3% next year.

Well then, it’s not all that bad, is it?

Maybe not, but when you remember that the Australian economy grew by around 4% in 2007, it shows just how quickly the economy is slowing.

Good point. So how far into the downturn are we right now?

As we explained yesterday in our sector-by-sector guide to the slowdown, the answer to that question very much depends on what type of business you are in.

ANZ senior economist Katie Dean told SmartCompany this morning that the economy is about one year into the downturn, although conditions have worsened considerably in the last few months as a result of the turmoil. “We were already set to slow before this crisis; now conditions are getting worse very quickly.”

What’s driving the slowdown?

Consumers and households. Yesterday’s consumer sentiment data from Westpac showed just how nervous the average punter has become, and they are closing their wallets at a rapid rate.

The complicating factor – and one that makes this downturn potentially different from previous recessions – is the extraordinarily level of household debt in Australia. For every $100 we earn, we owe around $160; back in the last deep recession of the early 1990s, we only owed $50 for every $100 we earned.

That means so much more of our incomes need to be spent paying off debt, which will make consumers stop spending even faster than in previous downturns, which means the slowdown could be deeper than we’ve seen for decades.

You’re starting to get me worried now. Tell me, what’s the worse case scenario?

OK, you asked for it. The worst doomsday synopsis we’ve seen comes from associate professor Steven Keen from the University of Western Sydney. His best case scenario is for a deep recession, worse than the 1990 recession a one-and-a-half times as long. His worst case scenario is an unemployment rate of 20% lasting for up to a decade.

Keen’s theory is based on a huge fall in house prices, which he says are running at seven times median income, compared to what he says is an affordable level of three times median income. House prices will have to come down and when that happens, the economy will crash.

Could he be right?

Potentially, although you won’t find many property experts agreeing with him. While there are plenty of predictions house prices will fall 10% over the next 12 months, most economists and property experts believe the recent cuts in interest rates and strong demand for housing will help support the property sector over the long term.

Right; any slightly better case scenarios about how long the downturn might last?

Katie Dean from ANZ Bank was expecting growth would start its long road to recovery during the middle of the second quarter of 2009, although the events of the last few weeks have forced her team to push expectations back towards the end of 2009. ANZ is forecasting economic growth of 2.4 % in 2008 and again in 2009, rising slightly to 2.6% in 2010.

But it will be a bumpy ride. Dean is expecting the unemployment rate to increase from 4.3% this year to 5.1% next year, and 5.4% by 2010, which will mean some ugly job losses.

She is also tipping business investment will fall from 9% in 2008 to 5.3% in 2009, way down to zero in 2010.

So I should be getting ready for at least 12 months of tough times?

At least. And be aware that the outlook could worsen very quickly in the coming months. But don’t worry, SmartCompany will keep you posted daily with the latest data – and it won’t cost you a cent.