"Every country that has gone through a period of financial deregulation has had hiccups – and that's understating it – along the way. There have been consequences that have been difficult to manage.

"The Chinese have studied all of everyone else's prior experiences in going down that path, so they're well aware of that. Maybe they won't make the same mistakes, but it doesn't mean they won't make a different mistake.

"It's pretty much the case that no country has gone through a period of financial deregulation and come through it with completely smooth sailing. Maybe China will be the first, or maybe not, and that remains to be seen."

So how would a crisis in China manifest itself in Australia?

In a new China debt crisis the Reserve Bank wouldn't be able to use conventional interest rate cuts as it did in 2008. Louie Douvis

Depending on how serious it is, the first and most obvious impact would be a collapse in Chinese imports of Australian resources. Prices for commodities such as iron ore and coal could be expected to slump, crunching the terms of trade, and delivering a hit to national incomes.

While the Australian dollar would almost certainly fall, providing a fair degree of support, its decline would also push up the cost of imports such as petrol.

Because most of China's debt is denominated in its own currency, if there was a crisis, foreign investors would probably suffer few direct consequences. But that ignores the possibility of unseen linkages across the global financial system. Few knew that the inability of people in the US to repay loans they should never have been given, would smash banks in Europe and the UK.


The big unknown is how a meltdown would affect Australian households, already confronting the bitter grind of low wages growth and record debt. What is currently fragile consumer sentiment would almost certainly be effected.

Treasurer Scott Morrison. If the government does resort to stimulus spending, it should be on productivity-boosting infrastructure – and that requires forethought and planning. Alex Ellinghausen

As the Reserve Bank warned this week, it won't be the "average" Australian mortgage holder, with a relatively high income, who finds themselves overwhelmed. It will be today's marginal borrower, who has gone too deep, with too few reserves.

A big question will be whether households believe the Australian government and the Reserve Bank have the required wherewithal to stabilise the situation as they have in the past.

On the latter, the Reserve Bank won't be able to use conventional interest rate cuts like it did at the height of the crisis in 2008 when it slashed the benchmark cash rate by more than 400 basis points within a few months.

With a cash rate firmly stuck on 1.5 per cent today, such a boost won't be available. The absence of interest rate fire power would almost certainly push the Reserve Bank towards the unconventional money-printing efforts used by central banks in Europe, Japan and US over recent years.

Morning commuters crowd through a major subway interchange station in downtown Shanghai, 2009. China has been a boon for Australia's economy. Qilai Shen

On fiscal policy, a serious China crisis would very likely be the final blow that sends government debt to levels seen in Europe and North America. The AAA rating would come under pressure and the cost of servicing the debt would rise.


Another concern; when the last big crisis reached its zenith in late 2008 and early 2009, it was the efforts of central banks and the Group of 20 nations – working in unison – that ensured the world economy avoided another Great Depression.

A decade later investors shouldn't be so sure of a repeat performance given today's paucity of global leadership, particularly from the United States.

All of those factors underscore the need for Australia to rebuild its reserves, both on the monetary and fiscal front. If the government does resort to stimulus spending, it should be on productivity-boosting infrastructure – and that requires forethought and planning. History shows that getting the timing right on this is very difficult as projects require planning, have long lead-up times, and only tend to hit their straps when the crisis has passed.

China has been a boon for Australia. Its centrally planned economy, which unleashed a huge stimulus package following the 2008 crisis, was a key factor in keeping Australia from a technical recession.

A crisis in China, which the bears have been forecasting for years now, would expose the downside of that vital relationship.

Panic would be the worst possible response. It also needn't be the case if policy makers and the public do what's needed to prepare.

The big unknown is how a meltdown would affect Australian households. Paul Rovere