Изменения в экономике - куда мы движемся?

31.08.2008

Эта стать написана специально для FinanceTalking Шарлоттой Муре www.lotsmoore.co.uk

Economic Conditions - Where are we going?

What a difference a year makes. This time twelve months ago it was business as usual. Few believed that the markets were teetering on the brink of a major financial shock. Global economic growth was robust and financial markets were booming.

Then came the credit crunch and everything changed. But it has not only been this financial crisis that has made life so very different this year compared with 2007; inflation, long thought to be dead, has risen Frankenstein-like from the grave.

Cheap debt to blame for all our woes
At first glance a credit crunch and the spiralling costs of the price of oil and wheat seem unrelated but, as is often the case with macroeconomics, the two were linked, the result of the same root cause: cheap money.

Cheap debt encouraged rapid economic growth. Every section of society was affected: private equity practitioners were able to carry out a huge volume of deals because of favourable financing, consumers leveraged their homes to buy plasma TVs and foreign holidays, governments took advantage of cheap debt to fund ambitious public spending plans.

As this was happening on a global level, capital flows between different regions changed from the previous economic norms. Consumer demand from the US and Europe meant that China and India’s economies grew rapidly. Rapid industrialisation of these regions led to booming middle class which increased demand for a broad range of commodities.

With cheap debt now but a dim and distant memory, the world is now struggling to cope with the legacy of both credit crunch and rampant inflation. Both will continue to have a profound effect on the global economy for several more years.

Aftershocks of the credit crunch
Any regular reader of the financial press may already feel overloaded by the endless column inches discussing the credit crunch. But there is little chance of the news flow diminishing; most commentators believe that full impact of this crisis has yet to be felt.

Let’s rewind to last year before the credit crunch hit. As explained, debt was cheap and banks were happy to lend to each other, to businesses and to consumers in a way that some, like the governor of the Bank of England, felt underestimated the risks involved.

Then sub-prime mortgage crisis happened. Far from being a simple crisis in a small part of the US mortgage market, it soon emerged that banks around the world were exposed to this sector. The sub-prime mortgage debt had been sliced and diced into an alphabet soup of products that had then been sold to institutions around the world.

The crisis triggered a collective lack of confidence in the world’s banking system. One day the world’s financial institutions were happily lending to each other, the next they had morphed into paranoid institutions with no confidence in each other’s credit history.

Credit dried up. The banks would only lend to each other at a rate considerably higher than the base rate.

And this is now affecting day to day business and consumer lending. While the number of businesses declaring bankruptcy and the number of repossessions are still at historically low levels, there is an increasing consensus in the City that these numbers will steadily rise in coming months.

There is anecdotal evidence that big companies have started to extend their credit payment terms from 60 to 90 days in attempt to move the pressure being put on them by their banks onto their suppliers, which could further accelerate the number of businesses going to the wall.

The banking sector has long moved away from its traditional business model where it used the deposits provided to it by customers to lend to others. Banks now use wholesale money markets to get access to far deeper levels of liquidity than cash deposits could provide. With this markets seizing up, it has called into question the whole principle of modern banking.

Problems bigger in the UK than the US
While this situation is the same for banks in both the US and the UK, there are reasons to believe it will take longer for UK banking system to resolve its problems that in the US.

The key to this difference is the different mandates governing the US Federal Reserve and the Bank of England’s monetary policy committee.

The MPC has to use its powers to set interest rates to meet the government-set inflation rate target while the Fed has no specific inflation target. This has enabled the Fed to sharply slash lending rates to 2% while the UK bank rate is stuck at 5%.

Before normal lending practices can resume, the banks have to rebuild their balance sheets. In the US, the lower interest rates are facilitating this refinancing.

In the UK, interest rates are simply too high so banks are forced to rebuild through rights issues alone. These are being beset by problems as the hedge fund community makes the most of its ability to short stocks to drive the share price of the banks below the rights price. This could mean that it may well take the UK banks two to three years to sort out their balance sheets.

Such a dearth of financing has serious implications for the health of the UK, especially as the economy became so used to easy access to capital. The housing market is already in deep shock, so much so that Gordon Brown is contemplating taking a leaf out of the Conservatives book by proposing a stamp duty holiday to add much need stimulus to the market.

Despite the Bank of England’s offer to replace mortgage-backed securities with government bonds, this will not be enough to completely rebuild the banking system. More likely is that the UK economy will just have to grin and bear it until normality has been resumed.

Stagflation re-born
The other side of the economic equation has been the re-birth of inflation. The growth of cheap debt meant that demand for commodities like crude oil, iron ore and wheat have built-up in recent years until that all important tipping point was reached when demand started to outstrip supply. At this point, prices started to ratchet inexorably upwards.

The recessionary impact of the credit crunch coupled with rising inflation has got economists and market commentators muttering about the re-birth of stagflation – that unholy combination of declining economic growth in combination with rising inflation that caused such hardship in the 1970s.

While individual central banks can use monetary policy to contain inflation, this has to be balanced against stifling the economy. So the central banks are facing a balancing act between not wanting to completely choke off economic growth while at the same not letting inflation spiral out of control.

It’s made much harder when inflationary forces are happening on a global basis with no one jurisdiction able to bring the cost of food and fuel prices into check.

An optimist might believe that an organisation like the IMF could put in place the necessary policies that would gain enough traction around the world with key governments to control inflation but most believe that it will be market forces that will eventually rebalance supply and demand. Like the credit crunch, there is little option but to grin and bear it.

Future outlook
All this may seem overly pessimistic compared with the current economic forecasts. While there has been much muttering about recession, which is technically defined as two quarters of economic contraction, there is no-one currently forecasting negative growth for either this year or 2009.

When the UK economy last went into recession at the start of the early 1990s, the economy had seven consecutive quarters of contraction. No economist is currently forecasting a similar trend in coming months.

The IMF recently predicted that the UK economy would face two tough years and said that it expects growth to be 1.4% this year and 1.1% next year. This may still be a positive forecast but only in May, it had forecast growth of 1.75% for both years.

But there is a growing sense among City economists that even those forecasts are overly optimistic and a strong probability that those forecasts will be revised down further.

The news and data that has emerged in recent weeks certainly supports that thesis. Marks and Spencer shocked the market in July when it said it sales had slumped and issued a profits warning. In the same month, the CBI said retailers have suffered their grimmest quarter for a quarter of a century.

In August, the Halifax said house prices last month were 11% down on a year earlier, the first double-digit decline since its monthly health check of the market was first published 25 years ago. Unemployment has started to edge up in recent months.

Gloominess about the future among economists and market commentators has deepened over the last year. Conventional wisdom has gradually changed from benign optimism to stoical acceptance. It’s unlikely that the economic picture is going to improve anytime soon.

This article was written for FinanceTalking by Charlotte Moore (www.lotsmoore.co.uk)