Investors beware! 'Madness' looms as lunatics have taken over the asylum
With deflation imminent the credit crisis will intensify in coming months as France's problems dominate agenda
AFTER the pounding the financial markets received in May and early June, some respite arrived towards the end of the month. Firstly, the election victory by pro-bailout parties in Greece calmed frayed nerves. Subsequently, the EU summit seemed to deliver some progress --finally, the cavalry arrived with co-ordinated action from central banks.
The ECB cut its main refinancing rate by 25 basis points to a record 0.75 per cent on July 5 and cut the deposit rate to zero for the first time.
The ECB action came the same day that China cut its key interest rate for the second time in a month and the Bank of England raised the target in its asset-purchase stimulus programme by £50bn £375bn (€478.2bn).
But all that is really a sideshow. There is too much unpayable debt in the world and the global slowdown is accelerating. The slowdown is becoming increasingly visible among the major economies. The US is still growing, but the latest Institute for Supply Management's manufacturing index fell in June to below 50, the first time in almost three years.
When it comes to measuring economic vitality, nothing is more important than employment. US payrolls increased by 80,000 jobs last month after a revised gain of 77,000 in May. Hugely disappointing. Retail sales fell for a third month in a row in June and GDP USA estimates are revised lower.
Germany's PMI came in below 50 (indicating contraction), with manufacturing PMI below 45. The 17-nation eurozone barely escaped official recession in the first quarter, but the region won't tread water much longer. Meanwhile, as Germany stagnates, France is likely to contract in the second quarter.
In Asia, too, an industrial slowdown is under way. China announced the lowest growth rates in three years, while both Korea and Singapore also revised numbers down. India is forecast to grow 6.1 per cent this year, from 6.8 per cent previously forecast. Brazil will expand 2.5 per cent, 0.6 percentage points less than in April, the IMF said.
When China cuts rates twice in one month, alarm bells should be sounding.
It is important to realise that authorities will not be able to protect core-Europe from the debt implosion. You cannot fight a systemic debt overload by piling on more debt. Governments or quasi-government institutions cannot continue to borrow at the current pace and expect to stay solvent. The Federal Reserve, and now the EU, are shifting the burden of trillions of dollars' worth of debt obligations from reckless creditors on to innocent savers and hapless taxpayers.
The endgame is always default. The only question now is, who loses and how it is done? Justice would have the reckless creditors pay. But governments and central banks want innocent taxpayers and savers to pay. The rest of Europe want Germany to pay. The bankers just want the end of the game to be delayed. In the end, we will all pay.
All action by our world leaders and central bankers has thus far centred on delaying the inevitable and creating inflation. Investors continued to buy stocks and commodities this spring on any rumour that promised inflation: European bank bailouts, Operation Twist, the Greek election, G8 summits, Fed meetings, Bernanke press conferences, improved economic numbers, predictions of QE3, central-bank interest-rate cuts -- you name it.
Unfortunately, the bond market is signalling it is deflation that is on the way. Deflation is a contraction in the overall supply of money and credit. Ultimately, it does not matter what the authorities do; they can't stop deflation until the debt burden is tackled instead of hidden.
Their refusal to grasp this simple concept condemns us to more turmoil. So, if you are invested in the stock market, now would be a good time to review your strategy -- and fast. If you have euro exposure you need to act -- last week the euro hit a two-year low against the dollar, a four-year low against sterling and a 12-year low against the yen.
Last month, Europe's credit crunch jumped from Greece and Portugal to Spain and Italy. In the months ahead, another country with a much bigger problem will steal the spotlight: France.
I expect the next phase of the credit crisis to intensify dramatically later in the year. By the end of this crisis, money will be free for the taking all over the world -- yet no one will want to borrow and few will be willing to lend.
At least Ireland's path is clear now. Firstly, it is imperative we get a comprehensive deal on our bank debt. While we cannot expect a unilateral write-off of bank debt now -- that should have been done earlier -- the most crucial point is the separation and warehousing of the debt into anything that removes the sovereign as the guarantor. We must try and achieve this before the rest of Europe unravels. It will be crucial later in the crisis as this debt is unlikely to ever be repaid.
Secondly, we must accelerate the structural reforms. Our main failure has always been utter inertia and our unwillingness to tackle vested interests. Finally, we must replace blind optimism with pragmatic realism.
Together we can fix this broken country.
Paul Sommerville's comprehensive analysis newsletter for the second half of 2012 is due out soon. It's free to Sunday Independent readers who register at www.sam.ie
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