Bulletin - The Credit Crisis Part III
The extraordinary banking debacle may have reached its endgame. While it is difficult to feel remotely confident of this, it is positive to see globally coordinated actions rather than just words or narrow national agendas. Concerns have now moved forward inevitably to the outlook for global growth, which has been exacerbated by the paralysis of lending.
Governments have moved to guarantee higher levels of deposits, inject capital into banks by various means, and underwrite inter-bank lending; meanwhile central banks continue to flood the financial markets with liquidity. This has received positive commentary but the desired effects may take weeks or months to flow through fully. Thus while the cost of insuring bank loans against default has dropped back, the price of lending between banks remains stubbornly high, and rates in the high street are more or less unchanged.
We are increasingly convinced that base rates will fall sharply. Central banks should become increasingly comfortable with the medium term outlook for inflation, and increasingly concerned about consumers retrenching. Western economies are so dependent upon domestic consumption and on debt that an easing of the policy grip on household cash flow is urgently required.
It is a relief to see UK petrol prices falling to below £1 again. Oil, and industrial and agricultural commodities have all fallen sharply in price, and this should feed through to lower prices on the high street. This should ease concerns about inflation which, when combined with increases in unemployment and a need to reduce high mortgage costs, will enable cuts in interest rates.
Longer term the outlook for inflation is cloudy, and experts’ views are polarised between those who fear deflation and those expecting the current enormous monetary stimulus to result in higher prices. The key factors will relate to how much is required to rebuild bank balance sheets, and how quickly funds are withdrawn when bank funding issues are resolved. Opinions will fluctuate.
It is also important to recognise that the billions of dollars, pounds and euros being thrown at the problem will not all end up as a cost to the taxpayer. The authorities are buying assets at distressed prices, and profits should be made on many of these. It is reported that already half the money put into Northern Rock by the Government has been repaid.
As regards economic growth there can be no dispute that the frozen financial markets have impacted the prospects for global growth, or that the UK, the US and Europe are either in or soon to be in recession. At last stock market analysts are cutting their estimates for corporate earnings in 2008 and 2009. Expectations are increasingly for earnings to improve again only in 2010. Investors are now coming to terms with this outlook, which should allow for improving confidence when stability in financial conditions is restored. The value of many companies now looks attractive longer term, but as Warren Buffett once commented, the one thing that people buy less of when prices fall is shares! We are tentatively buying.
This is not the end of capitalism or market economics. The Rule of Law can be defined as the balance between being free from and being free to. Social attitudes about what is acceptable change, and so laws change, and the impact upon specific freedoms changes, but freedom remains. So will it prove in the global economy. Regulations will change but not strangle the banking system; accounting practices will be amended, particularly relating to what should be disclosed on a balance sheet; banks will be required to hold higher levels of capital relative to their loans; and better scrutiny of management is needed. This is the social market adjusting itself.
16 October 2008