Judging by the reaction of Australian investors in the past week, we are on the way to following the US down the plughole to recession.
And while the impact of the credit crunch and slowdowns in Europe and the US will be felt here, we are in fact a long way from recession.
Rising inflation and a tight monetary policy are the central themes for Australia. Not falling interest rates and fiscal stimulus as in the US.
Central bankers are pretty cautious people. So you'd expect Reserve Bank Governor, Glenn Stevens to have been conservative in his assessment of Australia in the global scheme of things in his speech in London.
In fact if you read the most important parts of his speech, its an essentially optimistic appraisal of our current position. We have the problems of a well performing economy, not of a deflating one.
The decoupling idea has been pushed to one side, but there's still a strong influence being exerted on us by China, as Mr Stevens observed:
Much hinges on events in China, an economy that now has a very prominent effect on conditions in the Asian region. Over the past couple of years the Chinese economy has continued to boom, asset prices have surged and the authorities have struggled to contain the ebullience.
Some of China's growth has been courtesy of a rise in exports but, even if that contribution to growth diminished, China would still be growing very strongly as domestic spending has been rising rapidly. With very high saving rates at present, there would appear to be plenty of scope for further rises in consumption spending over time, as the Chinese people become accustomed to higher incomes.
A slower pace of growth in the G7 will presumably trim this growth to some extent. But my guess is that China can cope with that.
The Chinese authorities may even welcome some moderation in growth. If China does suffer a serious interruption to growth at some point – and all economies do from time to time – it is more likely, in my judgement, to be caused by some domestic problem than by the sort of events we are witnessing in the developed world at present.
For Australians, it will be just as important over the years ahead to keep an eye out for imbalances in the Chinese economy as to watch the problems of the US economy.
All told, it seems likely that, after several strong years, global growth will be noticeably slower in 2008.
Much of this slowing will be driven by weaker outcomes in the developed world, particularly in countries facing tighter credit conditions.
Some of the G7 economies are likely to experience a period of growth well below trend. It seems likely that this will affect emerging market and other economies mainly via trade linkages.
At this stage, it is not clear how significant this effect will be, but it seems prudent to assume that we will be moving from a position where growth in the global economy has been well above trend to one where it will be no more than trend.
Some moderation in the pace of global expansion is welcome, given the pressure on prices for energy and raw materials we have seen in recent years. But the full picture for this phase of the international cycle will become clearer only over time.
Australia
What then of the outlook for Australia?
The continuing rise of Chinese and other incomes through those levels at which resource usage intensifies significantly has meant strong and persistent demand over recent years for the mineral resources with which Australia is abundantly blessed.
At this point, there appears to be a widespread expectation that contract prices for some key resources will rise in 2008.
If they do, Australia's terms of trade, which have already risen by about 40 per cent over the past five years, would move higher still. Perhaps this general set of forces at work is behind the striking difference in confidence one encounters when travelling from the Pacific time zone to the European one.
It is not as though Australian investors and borrowers have escaped completely unscathed from the turmoil abroad.
While their direct exposure to the US sub-prime market has been limited, we have seen additional demand for liquidity put upward pressure on term funding rates for financial institutions, though to a smaller extent than in Europe or the US and the pressures are now easing somewhat.
Firms whose business models relied on short-term debt funding have been tested; a couple have, for practical purposes, left the scene.
Yet these events have been absorbed thus far with little disruption in the broader economy.
The availability of credit to sound borrowers has not been impaired. It costs a bit more, but that is in the context of a fully employed economy struggling to meet demand. The key banking institutions are strongly capitalised, have adequate liquidity and relatively little exposure to the problems in the US housing market.
Business and consumer confidence both remain high. In the local housing market over the past year, we have seen prices accelerate in several cities in the eastern states.
The economy grew significantly faster than trend over the same period. As a central bank, while we have been careful to ensure ample liquidity in the money market at a time of international uncertainty and re-pricing of risk, we have remained concerned about the outlook for inflation, which is likely to be uncomfortably high in the near term.
Based on what we can see at present, my judgement is that the direct financial effects of the global turmoil on Australia are likely to be confined mainly to the impact on borrowing costs of the liquidity squeeze of recent months, which has pushed up the cost of wholesale finance a bit in addition to the effects of monetary policy changes.
Taking into account the strength of demand, this increase in borrow
