Dow tumbles on new sub-prime fears

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The Independent Online

US stocks tumbled 2.6 per cent last night as an investigation of the home loan industry by New York's attorney general drew in the country's biggest mortgage finance companies, and the savings and loan company Washington Mutual warned the housing downturn would extend well into next year.

The Dow Jones index fell 360.9 to 13,300 after Andrew Cuomo said his office was sending subpoenas to the government-sponsored mortgage financiers Fannie Mae and Freddie Mac as part of an investigation of the home loan industry.

The move came as the dollar slumped below £2.10 against sterling, a level not seen since the early 1980s. The greenback dropped the most in two months against the yen, stumbled to a 23-year low versus the Australian dollar and, most galling of all, was down to a rate against the Canadian dollar not seen since 1950. In late New York trade, the dollar stood at $2.1023 to the pound.

The enfeebled dollar has, among other factors, also propelled the price of a barrel of oil to within touching distance of $100, an all-time high. In real, effective terms the oil price is also approaching the peak of 1979-80.

Oil, which settled down 33 cents to $96.37 a barrel in New York after surging to a record $98.62, is up 60 per cent on the year and has tripled since late 2003. Gold, another hedge against the dollar, has also been exploring new territory – at $845 an ounce, it is not far off its record value of $850, which was also last seen a quarter century ago.

Other commodities such as copper and wheat eased, but are still at historically high levels. The news that the average price of a litre of unleaded petrol in Britain has reached £1 is tangible proof that the commodities boom is indeed feeding through to the high street.

Equally worrying is the profit squeeze that the combination of a high pound and rising input prices will cause British industry. Exporters will find conditions much tougher as the dollar continues its two-year slide, while the costs of doing business – from fuel expenses to bank interest charges – seem to rise inexorably.

EEF chief economist Steve Radley said: "Manufacturers are continuing to benefit from a growing world economy for the moment. However, the combination of growing evidence of weakness in the United States and parts of Europe, a weaker dollar and an increased oil price will now be causing some to look over their shoulder at the prospect of more difficult conditions over the next year."

The probability of an old-fashioned "cost push" inflationary pressure on the global economy is more than apparent.

The danger for the US economy is that the dollar's decline – predicted and welcomed by bodies such as the IMF – becomes "disorderly", threatening an inflationary shock and further undermining the dollar's status as a reserve currency. Some smaller Gulf states have already begun to decouple their currencies from the dollar.

The other problem is the dollar's decline has been one-sided: while the euro, sterling and yen and other floating currencies are adjusting to help the US correct its trade deficit, the Chinese renminbi, which most analysts say is seriously undervalued, has seen only the gentlest of revaluations countenanced by the Chinese authorities. The renminbi is up just 8 per cent against the dollar since it was depegged in 2005.

In a demonstration of the shifting world balance of economic power, the dollar's problems were prompted by remarks from mid-ranking Chinese officials when Cheng Siwei, vice-chairman of China's National People's Congress, told a conference in Beijing about a possible adjustment in China's $1.43 trillion (£680bn) of reserves. Xu Jian, a central bank vice-director, added: "We will favour stronger currencies over weaker ones, and will readjust accordingly. The dollar is losing its status as the world currency."

Fears that the Chinese will diversify their reserves panicked the markets, though some observers took it as more of a hint from the Chinese that they would not revalue their currency without a fight. The renminbi has helped China become America's largest trading partner at the cost of a vast US trade deficit running into trillions of dollars.

The oil markets were spooked by more concrete figures. Crude oil rose above $98 a barrel in New York for the first time as American stocks of oil were reportedly much lower, declining by 821,000 barrels last week, from an already low base.

"This report wasn't the impetus needed to push prices over the $100 finish line," said Chip Hodge, a managing director at MFC Global Investment Management in Boston. Something will probably come up over the next couple days, which will do the job."

The Organisation of Petroleum Exporting Countries agreed in September to raise output starting about now to reduce prices, but that may not be enough to meet demand.

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