Australia’s house prices may be a casualty of Europe’s festering debt crisis. Photo: Arsineh Houspian

What an irony it would be if, just as our esteemed leaders finally squeezed their resources tax through parliament, there were no super profits left to tax.

If things keep heading south on world markets, the most the Mineral Resources Rent Tax will raise is a few musty old coins and some pocket fluff.

But that is the least of the government’s worries. As outgoing Commonwealth Bank chief Ralph Norris has told BusinessDay, the sovereign debt crisis in Europe is threatening to descend into a fully-fledged credit crisis where banks stop lending to each other.

The implications of another meltdown in credit markets are dire. Roughly a third of the funding for Australian mortgages comes from overseas bond markets. Were a third of the big banks’ sources of capital to suddenly dry up so would credit for housing markets here. Ergo, price drops.

This is the government’s greatest fear, that the great Aussie dream becomes a nightmare. Hence the favours to the banks, the recent fillip to funding from “covered bond” legislation and so forth.

This credit market squeeze is, as they say, the worst case scenario – and one which was narrowly averted in 2008 at the time of the Lehman Brothers collapse and the Wall Street bailout.

Then, the US banks were way over-geared. Now it is the European banks; with their leverage of 25-times only a modest fall in asset prices renders them technically insolvent. Many say a large swathe of them are already insolvent.

Most are not in a position to lend – especially since their sovereign governments are battling to raise money themselves on bond markets. What chance does an Australian bank have of selling bits of paper (bonds) to investors if the government of Germany itself failed to get a bond issue away this week?

Euro zone rescue

The consensus on markets is that this encroaching credit crisis Mark II won’t be averted until European leaders get their act together with a rescue plan for the euro zone, or commit US-style to printing trillions of dollars in new money.

Germany, with its haunting memories of the Weimar Republic, rampant inflation and the rise of fascism, is holding off on the printing-press option.

The other option is a rescue fund, an option for which many proposals have already failed and which requires leverage anyway, which again piles debt on debt.

Lest mortgage holders here fear a credit squeeze, and consequently falling house prices if conditions sharply deteriorate, there is also impending relief.

If banks do continue to lend to each other, and Europe gets its act together, rates should fall. The outlook for interest rates in Australia has improved dramatically over recent weeks. Since the Reserve Bank cut the cash rate from 4.75 per cent to 4.5 per cent, three-year government bonds have fallen in yield to 3 per cent (and the 10-year bonds hit a record low overnight).

That suggests the market thinks rates may drop by another 150 points over the next three years. Already the market is looking for a full one percentage point in rate cuts by March next year or another six 25-basis point cuts over the next seven months.

There is a yin for every yang in economics.

Downbeat view

The upbeat outlook for interest rates is squarely and proportionately due to the downbeat outlook for world markets.

There are few better indicators of the health and direction of the global economy than the Australian dollar. The Aussie dollar is a proxy for China, for global growth, for optimism itself, and it is now changing hands at 97.35 US cents, down 12 per cent from its July highs.

As the crisis in Europe deepened this week, and the deadlock over the US debt reduction plans remained unresolved, further economic releases from China spurred concerns that economic growth was slowing there as well (while fears flared anew over property price falls).

Vice-Premier Wang Qishan was quoted by China’s official news agency Xinhua that global recession was a certainty. “The one thing that we can be certain of, among all the uncertainties, is that the global economic recession caused by the international financial crisis will be chronic”.