Saturday, 6 December 2008

Storms overhead and storms in the economy

So, interest rates in the UK have been cut to levels not seen since 1951 and the £ has hit new lows against the Euro. The media have leapt onto the doom and gloom bandwagon with gusto - even The Sun now has a financial page that records the latest round of redundancies and failures. Looking on the bright side, the apocalyptic analyses and mass of gloom laden punditry tells me that that the market is slowly beginning to do its job and take out of circulation the credit fuelled excess of the last five or six years. Once the process begins the world economy will rebalance much more drastically and rapidly than this generation of Wall Street forecasters are expecting. The early part of the New Year through to mid-April is likely to be the eye of the storm as the economy moves inexorably towards finding its natural balance.

Trying to make sense of what is going on it would seem that :
  • Interest rates in the UK could fall to 1/2% by mid-2009 . Rate cuts might not prevent a recession , but like an airbag in a car they cushion the blow and stop the accident being worse than it might have been. As it is the economy in the UK will probably contract about 2 1/2% to 3% next year, with Italy falling a similar amount and France and Germany contracting between 1 1/2% and 2%. 2010 will probably be flat.
  • Households in the 25-40 year age group, who have used cheap credit most aggressively,are set to be the hardest hit. It is politically understandable, but somewhat financially contrarian , that many of the recent steps to stimulate the economy will allow these families to carry on spending and defer paying off the high debt levels that they cannot afford. The day of reckoning will eventually come probably with higher taxes and lower government spending - either way easy credit will need to be paid for.
  • Despite the government sponsored 'bailouts' UK and European bank balance sheets remain alarmingly weak. The banks are now being bombarded by a second and third round of problems caused by delinquencies in car, home, credit card and consumer loans. They simply cannot pass on these rate cuts to consumers without further endangering their own financial health. The obvious solution is for the government to scrap any pretence of being a passive shareholder by moving to nationalise them and pump cheap credit into the economy. If the banks can't lend then the contraction in the global economy will be much more onerous than anyone is currently predicting. Governments know this and will do anything to prevent a slide from severe recession into 1930's style depression - the probable long term inflationary impact of printing money will of course eventually come back to haunt us , but that is a follow-on crisis and can be worried about later by future administrations.
  • Although in denial. Austrian and Italian banks are horribly exposed to Eastern and Central European consumer loans - who in their right mind would provide Swiss Franc mortgages to Hungarians on Forint denominated assets?. As those economies slow the weaknesses that have been seen in the UK banking sector will require additional capital injections by some Eurozone governments. German banks are still leveraged to more than forty times their balance sheets - a number that will rapidly contract back towards twenty five or thirty times.
  • Everyone expects China to rescue the global economy by growing at a robust 8% in 2009. I have to ask who is going to buy all these Chinese goods and with what? Interesting to note that China's power consumption in October was down nearly 4% year-on-year, the first easing in a decade. Twenty plus years of looking at emerging markets tells me that minimal Chinese growth is to be expected by Q1 next year as western consumers shift from buying to saving. Yesterdays sale of Chinese contemporary art in Singapore saw half of the already heavily discounted lots remaining unsold.
  • Retailers are left with large Christmas inventories which they will have to unload at nearly any price. The January Sales , for those shopkeepers who get that far, should be barnstormers for bargain hunters. In the US Black Thursday sales were up but margins were miserable. It is still the case on the evidence to hand that shopping remains the leading hobby of most households.
  • The unravelling of these large inventory levels point to awful earnings and margins through next year. The good news is that the enforced stock clearance and liquidations will at least clear the way for the laws of supply and demand to come back into balance in early 2010 and open the way for recovery in 2011. By that time GM and Chrysler will be a shadow of their former selves.
  • Why would anyone buy Russian equities in future? The Moscow market must have been closed by the authorities at least ten times since September.What is the point of owning stock if you can't sell it and you can't get a clear valuation for what it is you own. My guess is that in the next oil cycle institutions will be keener to own the German exporters to Russia where corruption is minimal, earnings numbers transparent and trading professional.
  • The net of all of this is that at some stage the printing of all this new money could lead to the resurgence of inflation 'red in tooth and claw'. For the time being with the global economy in reverse gear there is plenty of time to sit on the sidelines and wait to see how things develop. US equity markets should enjoy a yearend rally in the belief that President Obama will inject a huge amount of demand into the economy through a $600 billion stimulus package.Europeans bourses are only now waking upto the fact that demand for those Mercedes and BMW's isn't going to come back overnight and that a long period of slow demand stretches ahead.

    All in all this downturn is rather like being in the dentists chair . The government is pumping us full of anaesthetic by cutting rates, lowering taxes and doing everything possible to divert our attention away from the coming pain. We just have to hope that the anaesthetic being provided is strong enough to work and that there is enough of it to last while the raw nerve is being worked on!

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