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Let us hope this is not a repeat of the crisis of 2008

Allister Heath
WE have stumbled into another mini-financial crisis, one which has an outside chance of bringing the global recovery to a shuddering halt. The debt crisis in the Eurozone, far from having been sorted out with the help of German taxpayers’ money, is getting steadily worse, contaminating global financial markets; jittery investors are panicking at every piece of bad news, such as yesterday’s worry about the possibility of war on the Korean peninsula. Fortunately, the situation is not yet out of control but the current turbulence looks eerily like a repeat of what followed the demise of Bear Stearns in 2008, a few months before Lehman’s collapse.

The high-yield debt market is freezing up, the price of gold – the traditional safe haven and inflation hedge – has jumped and is now nudging $1,200, corporate bond issuance has collapsed over the past two weeks, equity markets are down 10 per cent, the euro is tumbling to four-year lows against the greenback, risk-aversion is rising, as is volatility. Commodity prices, including oil, are down on worries of another slowdown, which could reduce their demand. Stupid political responses, especially by German chancellor Angela Merkel, have made matters worse; her original decision to curtail short-selling fuelled fears that she knew something the markets didn’t. Her latest attempts at tightening the ban will be just as useless and counter-productive. The uncertainty about how US banks will be regulated has also spooked markets, as have the daily hints at yet further taxes for the sector globally.

Meanwhile, the European Central Bank has started snapping up bonds and increasing the amount of liquidity it provides to the markets, suggesting that it is even more worried than it is letting on. The three-month Libor rate at which banks lend funds to each other has risen to its highest level since July 2009. Banks have become more wary of lending, especially to European institutions, a situation which worsened further after the Spanish government’s rescue of a local bank over the weekend. Rising Libor rates raise banks’ funding costs; this has a knock-on effect on all other forms of borrowing.

Conflicting views about inflation and deflation are also fuelling jitters: consumer prices are growing much too quickly in the UK, while many are worried about the possibility of Japanese-style deflation in the Eurozone and (less plausibly) in the US, on concerns that the money supply is failing to grow quickly enough.

In some cases, markets have fallen too far, triggering buying opportunities. The S&P 500 rose slightly last night after paring losses late in the session as investors bought beaten-down shares. But other assets look over-valued again, including UK residential property, and there is far too much dodgy sovereign debt around.

So how will all of this gloomy picture in the financial markets affect the real UK economy? The answer, quite simply, is that it depends on how bad the Eurozone sovereign crisis turns out to be. If the region muddles through, we will be fine; a controlled crisis, with agreed haircuts on the debt of some countries and their orderly exit from the euro, would hurt but not derail the UK?recovery; a full blown disaster in Europe, with a shock default a la Lehman and financial firms going bust would have unimaginable consequences.

It was good news that the UK’s growth rate in the first quarter was revised up to 0.3 per cent on the back of stronger industrial output. UK statistics consistently underestimate growth. Citigroup has calculated that in 1997-09, quarterly GDP stats were on average always revised up by 0.1 per cent. The upgrade is greater when the initial GDP figure, as at present, is low – in such cases, the initial data averaged 0.33 per cent and was eventually revised up to 0.65 per cent.

The UK , despite its many problems, has four things going for it: first, the new coalition has reassured the markets regarding the deficit and sent gilt yields tumbling; second, corporate profits are recovering and the private business sector is lean, cash rich and profitable; third, the economy is growing steadily, if frustratingly slowly; fourth, global growth, especially in Asia and the US, remains buoyant, helping exporters. As long as Europe doesn’t implode completely, and the geopolitical situation remains stable, continued but sluggish growth still remains the most likely outcome over the next year in Britain. Fingers crossed.
allister.heath@cityam.com