Australian Lefty on Politics, Governance, Science and Info Management

Bears stern, dragon happy, bulls hit

Posted by Dave Bath on 2007-08-26

Recent market volatility has come from the finance industry playing "pass the parcel", although with a twist: everyone has a parcel, and nobody knows how much debt is in each.  The music stopped, and everyone panicked.

Reserve banks came to the rescue with more music, and the finance industry picked up where it left off, all too happy to ignore the problems in the parcels.  But the reserve banks (apart from perhaps the Chinese) haven’t got an endless supply of liquidity, so the inevitable reckoning has merely been deferred.

We can learn much by looking at the markets that went up when most markets dropped by 4% to 6% in the week ending 2007-08-18, what has enabled a minor recovery, as well as medium term trends that presage further turmoil.

  • The Chinese SSEA index still rose 4.5%, slightly under par, while the SSEB rose marginally in US$ terms despite the greenback’s fall;
  • Saudi and Venezulan indices rose a little, but they are oil producers and less dependent on the US economy;
  • Germany’s DAX wasn’t too badly mauled, losing only 2.4%;
  • CDS (Credit Default Swap) boards had massive gains, approximately a quarter of the calendar year so far;
  • the $US dollar fell less than the A$, even though Oz loans are notionally more secure; and
  • while money fled to the real economy away from paper, metals and industrials dropped markedly while food items rose sharply, continuing the trends of the last quarter or so.

The rise in the CDS indices was the most significant, both numerically, and in what it says about the expectation of the smart money: more loans will default.

This time around, the defaults will be by households, not by business.

For the last five years, businesses have been able to finance capital investment from record profits rather than accumulating debt (apart from a few debt-financed private equity buyouts that now begin to look unwise).  Especially in countries like Australia and the US, it is households that have record indebtedness, households that will default or tighten their belts.

Discretionary expenditure can be expected to plummet – which is one of the reasons why food item futures have increased while lead indicators for discretionary expenditure like industrial futures have fallen.

It’s going to be an ugly Christmas for Australian retailers.  Dads will be getting the minimalist chocolate coated nuts, socks and jocks rather than electronic gizmos.

But for me, the volatility of all markets apart from China in the last couple of weeks may be significant for future historians: the received wisdom about the US economy sneezing and the world catching a cold is no longer valid.  China’s economic dominance was signalled when a Chinese market jitter caused worldwide falls.  This time, the US showed signs of emphysema, and the dragon didn’t sniffle once.


2 Responses to “Bears stern, dragon happy, bulls hit”

  1. Raf said

    Yes the markets have bounced back as the liquidity infusion eases fears. But as you say this is merely the froth coming off the top. The seriousness of the banking system freezing up should not be understated.

    Simply put, the banking system would have tipped over without central bank intervention. Whilst in the short term this is helpful we know it merely masks a very extended debt situation.

    The reason China seems immune is people are way less exposed to debt. In the G7 countries personal debt outweighs personal GDP.

    It’s hard to have faith in finance companies, which in NZ are dropping like flies, but when faith in the banking system itself is shaken then you have a major problem.

  2. Dave Bath said

    I’ve referred to a good series of VoxEU posts on this topic here. I’ve only picked out a couple of their papers, but their whole series on this issue is pretty darn good.

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