By Michael Baxter 7 May 2010 [0 Comments | 749 views]
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Fears over Greek contagion spread to the other side of the pond yesterday as markets, indifferent to the UK election, saw their nerves stretched to the limit. The Dow saw a quite extraordinary day of volatility, Angela Merkel made the most passionate speech of her career as she warned the EU itself is under threat, and a credit ratings agency warned that Greek contagion could spread to the UK banks. Meanwhile, as the economic empire burned, the ECB president played with his fiddle.
Markets crash, but computer glitch provides partial explanation
At one point yesterday the Dow Jones was down a stunning 998.5 points, or 9.2 per cent, the biggest one-day drop since 1987, before staging a comeback. For a while it seemed the US stock market crash could actually eclipse news of the election in the UK media. (On second thoughts, maybe not, it seems not even the Second Coming or an invasion by Martians could have managed that feat.) But the Dow finally ended the day a mere 346 points down, a big fall of course, in fact it was the biggest one-day drop since that momentous of all months, September 2008, but even so it was a trivial drop compared to the day’s earlier losses.
But it seems the big falls were largely explained by technical glitches. Many of the trading systems are programmed to automatically sell if stocks fall by a certain amount. Yesterday was a day of extreme volatility, and for a while certain stocks had fallen quite steeply. This triggered off automatic selling, exacerbating the fall. At one point shares in Procter and Gamble were down by a stunning 37 per cent. On its own this fall made up 172 points of the day’s losses. Yet the stock finished the day just 2 per cent down on the opening price.
But while much of the falls can be explained by quirks in the trading systems, the drops nevertheless showed how pensive markets are.
Banking crisis 2?
The wounds of September 2008, when Lehman Brothers went bust, have not healed, and markets are terrified that the Greek contagion could spread. Even if Greece was to default, the disaster would not be on the same scale as the Lehman Brothers collapse. But many are drawing parallels between Greece and Bear Stearns, the bank which was rescued before the Lehman Brothers collapse. Greek rioters have made clear their disquiet over the impending austerity drive. The risk of default remains high. Markets fear that Greece is simply unable/unwilling to make the necessary cuts, and these fears alone are creating further worries that Spain, Portugal and the rest of the motley crew will follow Greece into sovereign debt hell.
Moody’s, the credit ratings agency, rubbed salt into the wound. It warned that “the banking systems of Portugal, Spain, but also Ireland, the UK and Italy are increasingly moving into the focus of the markets.” The Moody’s note stated: “Each of these countries’ banking systems faces different challenges of different magnitudes, but… risk could dilute these differences and impose very real, common threats on all of them.”
Fears of another banking crisis sent shockwaves through markets across the globe, with bank stocks falling steeply yesterday, and this time the falls had nothing to do with technical hitches.
UK stuck between rock and hard place
As for the UK, Moody’s made a ‘stuck between a rock and a hard place comment,’ saying: “The UK is in a difficult position: if it were to tighten fiscal conditions too quickly, then this could lead to further asset quality challenges in the banking system, potentially choking off economic recovery… Alternatively, if the UK did not tighten fiscal conditions soon and credibly enough, then the financial flexibility of the sovereign may diminish as market opinion may move against the UK.”
Blame the messenger
Earlier this week, the EU Commission seemed to suggest the real problem with the economy was the rating agencies themselves. José Manuel Barroso said of the credit ratings agencies: “Deficiencies in their working methods has led to ratings being too cyclical, too reliant on the general market mood rather than on fundamentals – regardless of whether market mood is too optimistic or too pessimistic.” He may have a point. Or maybe instead this is all about European sensibilities and hating to have US companies pointing out their shortcomings. Markets can be irrational, but they can also be rather effective at pointing out errors. They messed up during the build up to the credit crisis, but it does not necessarily follow they are messing up now. A few days earlier in the week Michel Barnier, the European commissioner in charge of an overhaul of financial services, said: “There are not enough ratings agencies, not enough competition and not enough diversity. Why should there not be an agency that is more European than those that exist today?” And then he left one big question hanging: should an alternative European agency be state or privately owned?
Merkel warns of threat to EU
Meanwhile, in Germany Angela Merkel made no effort to mince her words.
While the Greeks hate the terms of the rescue package which they see as being far too tough, the Germans feel the Greek bailout is too soft. But Ms Merkel told the German parliament: “This is about nothing less than the future of Europe… and with it the future of Germany in Europe.” Her warning continued: “We are at a crossroads… There is no alternative to the planned aid for Greece, we want to secure the financial stability of the euro area. It must come, in order to fend off a chain reaction in the European and international financial system.”
Strong words, but frankly the German ‘will it, won’t it’ rescue of Greece has an element of farce about it. Every few days we are told a Greek deal has been agreed. But when you keep presenting the same information as if it is news, one can’t help feeling confused. How many times does the EU need to announce its rescue of Greece? No wonder markets are so spooked.
Playing the fiddle
Earlier this week The Telegraph ran a piece suggesting the IMF would be unable to afford a Greek style rescue for other countries if the contagion spread to Spain, Portugal, Italy and, horror of horrors, the UK. If these countries were to enjoy an IMF bailout of the same scale relative to their IMF quota as Greece, then the IMF would have to find around $1 trillion. This would surely be impossible.
No wonder rumours are circulating that the European Central Bank will have to go nuclear and take a leaf out of the Fed and Bank of England books and print money. But yesterday the European Central Bank’s President Jean-Claude Trichet said: “We did not discuss the matter. I have nothing more to say on it.”
But markets are not convinced. Mythology says the Emperor Nero played the fiddle while Rome burnt, but in fact this is not true, and he did all he could to deal with Rome’s fire. Mr Trichet may talk the talk of doing nothing, but inside he must surely be feeling quite different.
Nuclear monetary option
This has inevitably led to further talk that the only solution to the debt crisis will ultimately be via governments inflating their way out of difficulty – the hyperinflation bogey is back on commentators’ minds. But we still stick to the view that globally we are seeing demand lag way below potential supply. There is enormous slack in the global economy. This is nothing like the 1970s, when supply was stretched wafer thin. The real danger for central banks lies in the threat of pushing up asset prices. Indeed, central banks have said they want to achieve this, because rising asset prices will lead to rising demand. But there is a danger of seeing the twin evils of falling High Street prices but rising asset prices.
The truth is, however, that the net effect of massive levels of global savings is that money is flowing into safe havens, namely US government debt. A perverse effect of the global savings glut is that while US fiscal debt is soaring, so is demand for US government bonds. The underlying problem of global demand not keeping pace with global rises in potential supply has not gone away, and until this problem is fixed, we will lurch from one crisis to the next.
