Some light reading for breakfast.
I get the feeling of unreality sometimes lately when I raise my eyes
from the appalling facts to hear the party activists going on as
though this were some small technical adjustment.
The two that follow are not 100% in agreement but at least they are
more serious than most and know what's at stake.
xxxxxxxxxx cs
========================
TELEGRAPH 18.12.08
1. Fresh credit strains in Europe as Deutsche Bank shocks markets
Deutsche Bank has refused to redeem a bond issue in an unprecedented
move that has rattled Europe's credit markets and cut short the
relief rally following America's dramatic move to zero rates.
By Ambrose Evans-Pritchard
The news set off a fresh flight from European bank debt. Credit
default swaps (CDS) on the iTraxx Financial index measuring stress in
the sector saw the biggest jump since the Lehman Brothers crisis,
rising 20 points to 226.
Adding to the gloom, Standard & Poor's warned that,a fifth of all
lower-rated companies in Western Europe and the UK are likely to
default over the next two years greatly exceeding the scale of
bankruptcies after the dotcom bust. The agency said up to 75
companies that issue debt in the capital markets would fail in 2009
as they struggle to roll over debt. Four have failed this year.
Deutsche Bank, Germany's top lender, said it had chosen not to
exercise a "call option" on a subordinated bond worth ?1bn (£930bn),
breaking an iron-fast code in the credit markets. The bank's share
price fell 7pc in Frankfurt, and the default insurance on the
company's debt surged. "This has never happened before," said Willem
Sels, a credit strategist at Dresdner Kleinwort. "Banks have never
wanted to do it because it upsets investors and could mean that
future funding will be hit."
Deutsche Bank, run by Josef Ackerman, is within its legal rights. The
contract lets the bank accept an automatic rise in interest costs
after five years, or call the option and raise money on the open market.
Ronald Weichert, the bank's spokesman, said it would have been "much
more expensive" to secure fresh finance in the current climate. "The
situation has changed, and we had to decide what to do in the
appropriate interests of Deutsche Bank," he said.
The travails at Deutsche are the latest sign that credit stress is
continuing to plague Europe's lenders, despite a blanket bail-out by
EU governments in September.
The European Central Bank warned in its Financial Stability Report
this week that lenders are at risk from a deeper slowdown than
expected. "Banks need to be especially vigilant in ensuring that they
have adequate capital and liquidity buffers to cushion the risks that
lie ahead," it said.
The ECB is coming under heavy pressure to follow the Federal Reserve
and central banks of Canada, Britain, Switzerland and Sweden in
slashing rates and exploring emergency options. Norway cut rates by
175 basis points to 3pc on Wednesday.
Eurozone prices fell 0.5pc in November and may be flirting with
deflation by the middle of next year. The region is falling into deep
recession. Berlin expects the economy to contract by 2pc next year in
the worst slump since World War Two, according to German press leaks.
Italy is facing two years of contraction. Concerns are spilling over
into the debt markets. Yields on Italy's 10-year bonds have risen to
132 basis points above German Bunds, partly on concerns that Italy
may have trouble rolling over ?200bn next year.
Jean-Claude Trichet, the ECB's president, this week hinted that the
bank may hold rates at 2.5pc in January. "Do we have a feeling there
is a limit to the decrease in rates? At this stage certainly yes. We
have to beware of being trapped at nominal rates that would be much
too low."
ECB hawks have been warning that extreme rate cuts are unhealthy and
likely to lead to inflation down the road, although there have been
rumblings of discontent from the Dutch, Cypriot, Portuguese and
Spanish members.
There is now a stark divide in philosophy between the ECB and almost
every other central bank. The result has been a sudden shift of funds
into the euro over recent days, pushing it to $1.44 against the
dollar and a record ?1.0758 against sterling
=-=-=-=-=-=-=-=-=-=-=-=-=-=-
2. Free money coming your way!
The crisis is so bad that governments are ready to print money to
stop the economy seizing up.
By Edmund Conway, Economics Editor
New year is a time for new beginnings; for resolutions; for sweeping
out the old and making a fresh start. But never before has the
turning of the year brought such a transformation for the economic
landscape. When the sun rises on January 1, it will do so on a world
which has changed beyond recognition, a world in which interest rates
are no longer the chief tool for economic policy-making and
helicopter drops of money are the modus operandi; in which the
banking system - that once-great foundation for the global economy -
is on the brink of nationalisation; and in which the big question is
not how much wealth the economy is capable of generating in the
coming 12 months, but whether it faces a year or a decade of recession.
If anyone harboured doubts as to the scale of the crisis, these would
have been dispelled on Tuesday night. Not only did the United States
Federal Reserve cut its benchmark rate to zero; it also indicated
that it will leave rates there for some considerable time and that it
will pull out the big guns - in other words ready the printing
presses - to fight the worsening crisis. The following morning we
learned that the Bank of England had been considering reducing rates
by even more than the percentage point it opted for this month. Zero
- or near zero - interest rates are only a few months away on these
shores.
These are drastic measures, but understandable when one considers the
scale of the economic devastation thrown up by the financial crisis.
It is not merely that most of the Western world is now in recession,
but that its scale is of a kind few of us have experienced. Only
months ago it seemed hyperbolic to compare it with that of the early
1990s - still less the 1970s or, God forbid, the 1930s. But the
statistics are bearing out the pessimists' worst fears. Unemployment
is rising at the fastest rate since the 1970s in the US, and in
Britain faster than at most points during the last recession. Two
million people will be jobless by Christmas. Companies of all hues,
in all sectors, are laying off workers and slashing investment. Banks
are cutting credit lines and leaving many firms facing bankruptcy.
House prices are falling at a sharper rate than in modern history.
Even so, the fact that the Fed is advocating the sort of helicopter
drops of cash Milton Friedman and Ben Bernanke once speculated about
is startling. For as long as we can remember - whether you were
trying to manipulate levels of money in the economy, as in the 1970s
and early 1980s, or inflation, as in the 1990s and 2000s - interest
rates have been the key tool at policy-makers' disposal. Those days
are over. Instead, the Fed must control the economy by pumping money
in and out directly. It must directly buy up assets until the economy
finds its feet again. This has alarming precedents: it was the
printing presses that did for Weimar Germany, and sparked Zimbabwean
hyperinflation.
Should quantitative easing [I warned you to look out for this one! -
cs] - as central bankers call these measures - prevent a long, drawn-
out period of deflation, it would do so only at the cost of brewing
up a tremendous bout of inflation in subsequent years. Whether this
results in double-digit inflation is academic: the upshot will be a
sharp rise in interest rates for a long period. A year or so ago it
was fashionable to paraphrase Robert Frost to warn that we are
trapped between the extremes of fire and ice. The contrast today is
even more stark: on the one hand lies a long, potentially inescapable
stretch of deflation, on the other is high inflation, high interest
rates and sluggish growth.
As bad a taste as it may leave in the mouth, I feel the inflation
option is the better one. This might seem peculiar given that the
Consumer Price Index is still above 4 per cent, but before long the
UK will be experiencing widespread falls in prices. Soon, we will be
crying out for a little dose of inflation.
So, the chances are that the Bank of England will follow the Fed and
drop rates to zero - or thereabouts. And life will start getting
rather peculiar. It is not inconceivable that banks could start
charging customers to hold their money - after all, their business
model is predicated on positive interest rates. Some lucky households
- those who took out tracker mortgages a few years ago - may find
themselves with a negative interest rate, where their bank should be
paying them for the privilege of holding their money. All of these
things are possible with zero interest rates, though the Bank will
most likely ape the Fed and cut only to a half or quarter percentage
point.
Mainly, though, just as the millennium bug sparked fears of a
computer meltdown, the worry is that zero interest rates would cause
an unpredictable chain reaction of destruction in the financial system.
The one thing likely to save us from the big zero is the pound's
weakness. We are not in a sterling crisis - not yet at least. When
currencies fall they usually do so for one of two reasons: because
investors are worried that the economy is heading for a slump, or
because they have lost faith in the people running the country. All
the indications are that the pound's fall has owed more to the
former; indeed, the yield on government debt, a key sign of faith in
economic management, has dropped to the lowest levels in more than 20
years.
But while an International Monetary Fund bail-out is only a distant
possibility, one cannot rule it out. The problem is that, for all
those trillion-dollar figures that float around, we still don't know
precisely the scale of the losses facing the banking system. The
poisonous potion of mortgage debt which brought down the lenders has
not yet been drawn out of the system, and governments have
concentrated on life support. So, despite a £50 billion infusion of
public cash, Royal Bank of Scotland, HBOS and Lloyds TSB are still
having to cut the amount they are lending, as they scramble to repair
balance sheets. While this is to be expected, it has the by-product
of worsening the slowdown. In a recession there are always plenty of
opportunities to find bargains, but what if no one will lend you the
money to buy one?
All of which is why it looks increasingly likely that the Government
will have to go one step further towards nationalising the banking
system. Just when you thought the financial crisis had died down - to
be replaced by the economic slump - it returns. As the Bank Governor,
Mervyn King, warned the Chancellor this week, the coming months will
see more public money having to be put behind the banks. This is not
quite the same as nationalising the "means of production" in an
effort to exert government control, it is temporary hospitalisation.
This is not Old Labour - it is new nationalisation, or, for those on
the other side of the Atlantic, neo-nationalisation.
It is hard to predict what will emerge from this wreckage, but now is
not the time to write the obituary of the US or the UK economy. The
next few years will be tough, but we are not alone. Nowhere - not
China, not the Middle East - will escape this slump. Times are bleak,
and will remain so for a while. But the chances are that this time
next year we will be talking about the green shoots of recovery, and
speculating how long before the strange parallel world of zero
interest rates comes to an end. [Incurable optimist! -cs]
Posts
