Is this the start of the next financial crash?

History repeats itself four years on, as the global markets go into meltdown. Julian Knight reports

Sunday 07 August 2011 00:00
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History is repeating itself four years on, as the global markets go into meltdown
History is repeating itself four years on, as the global markets go into meltdown

Maybe it's something to do with its being August, with much of the world's top brass away, but it's becoming a month notorious for market turmoil. Four years ago last week the jaws of the credit crunch snapped shut. The start was marked by investment bank BNP Paribas closing two of its funds exposed to the US sub-prime crisis on 9 August 2007. Within just a few weeks, the queues of worried customers were forming outside the Northern Rock.

Four years on, and numerous bailouts later, the world economy seems once again to be standing on the precipice, with stock markets around the world losing billions of dollars in one of the bloodiest meltdowns since the 2008 crash. Share prices fell in Brazil, Tokyo, New York, London, Mexico and across Europe.

More than 10 per cent was wiped off the FTSE 100 index in London – equivalent to £270 bn – on the week and £144bn was lost on Friday alone. It closed 600 points down on the week to 5240, about the same level as it started the year. In New York the Dow Jones plunged by 5.3 per cent on the week.

Angus Campbell, the head of sales at Capital Spreads, said on Friday: "At the beginning of the year, investors were expecting global growth ... But now there is a massive rethink as it looks like global growth could stall. This has caused a tremendous amount of selling – it really is a herd mentality."

This time around, sub-prime lending is not at the root of the problem, but something potentially far worse. Many Western governments, having bailed out the banks and followed the Keynesian model of priming the spending pump in a recession, are now so saddled with debt that markets are losing faith that they'll ever be able to meet the interest payments, never mind pay it back. The seemingly never-ending line of credit to governments, which underpins the financial system and your pension fund, is what has been crunched this time around.

Last week, the Spanish government saw the cost of its borrowing rise by 0.5 per cent in a fortnight – it's now 4 per cent more expensive for the Spanish government to borrow than Germany's. But the Spanish may not be in such a bad place as the Italians. Market and political turmoil are going hand in hand in Rome with Silvio Berlusconi's lame-duck government, which is doing very little to dampen the impression that, with debt equal to 128 per cent of GDP, the eighth-largest economy in the world can't pay its way. Again, the rate of interest the Italians are paying is moving in line with Spain's towards Greek levels.

The problem for Italy is more acute, as a lot of its debt is short term, which means it has to call on the markets to refinance more regularly than the Spanish, Irish and Greeks. Italy isn't bust, but its being pulled into the vortex is a massive upping of the stakes for Europe's politicians and the European Central Bank. Some analysts suggest that the ¤1trn bailout package agreed just a fortnight ago would have to be ¤4trn if the Italians can't get rid of their debt and need bailing out. Such a bill may be even too much for the Germans. No wonder Jyrki Katainen, the Finnish Prime Minister, lamented last week that Europe was "in a very dangerous situation".

Facing markets in freefall last week, the ECB chief, Jean-Claude Trichet, has told Spain and Italy to draw up new austerity packages. The Spanish will reveal theirs on 19 August while the Italians have said they will try to reach "a national consensus" by September.

"In a nutshell, the ECB has sent an implicit invitation to Spain and Italy to do more. This probably needs to be fleshed out. If things turn spectacularly sour in the next few weeks, the ECB would have no choice other than expanding its buying of government bonds," Gilles Moec, a Deutsche Bank economist, said. Spanish and Italian debt could thus be soon bought en masse by the ECB, as is already happening with Greek debt.

But Mr Trichet revealed that the ECB is not unanimous on the need to buy Italian and Spanish debt. Traders also had the words ringing in their ears of the European Commission chief, José Manuel Barroso, spoken on 21 July, that he had "deep concerns" about the Spanish and Italian economies. He put part of the blame on what he called "undisciplined communication and complexity and incompleteness" of the earlier Greek bailout package.

In short, markets are jittery and waiting to see the i's dotted and T's crossed on the Greek bailout. "A month ago we saw the end in sight, but now we could have another four to five years to go. What we have witnessed is a psychological change. The difference now with the first credit crunch is we saw a co-ordinated movement towards rescue. But now all we are seeing is a piecemeal effort," said David Bloom, HSBC's head of foreign exchange strategy.

Slow action and political wrangling at the heart of the eurozone seem a big problem for markets: "With the Lehmann crisis, we had Hank Paulson and some key leaders who could call everyone together and quickly deal with things. For Europe, we cannot do that. There is institutional weakness," said Dan Morris, market strategist at JP Morgan.

All this is against a backdrop of concerns over the EU and UK banking systems; having been battered in the credit crunch and bailed out by taxpayers, the banks now face the prospect of what they thought were their gold-plated investments – government debt – being worth far less than they originally thought. And it's here where real dangers lie for the UK.

British banks hold masses of eurozone debt – last week RBS wrote down £733m of Greek government debt – but that is small fry. Some estimates put UK bank exposure to eurozone government debt at a staggering £200bn. However, despite this potentially massive liability, the UK is viewed as a bit of a safe haven, with the Government able to borrow at the lowest rates in 50 years.

But there is another potential storm out there for investors. The US economic numbers aren't that good and with this comes the fear of a global double-dip recession. Even the emerging markets aren't safe: "We have several contagions going around the world economy at once and this hits the developing economies because their biggest markets are the US and Europe," said Phil Poole, HSBC's head of global and investment strategy.

Karl Marx, who no doubt would have revelled in the market bloodbath, once said: "History repeats itself, the first time as tragedy, the second time as farce." The past week has certainly felt like history repeating itself, with more than a touch of farce.

Additional reporting by Laura Chesters

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