Evercore Pan Asset

There are strong indications that worldwide governments are now taking more decisions to fight recession. They think the worst of the banking crisis is behind them, because the Americans, Europeans and British have all offered substantial sums of new taxpayer capital to help pay the forthcoming losses on overextended loan books. They now belatedly realise they kept money too tight for too long, and this will force the major western economies into recession, and the major eastern economies into slowdown.

In the USA and the UK the politicians have decided on tax cuts or on beefed up welfare payments for the casualties of the downturn. They wish to add fiscal stimulus to the monetary stimulus they are trying to create through lower interest rates and the supply of more liquidity to markets. There is also talk of enhanced public works programmes, but these take time to bring to reality given the long planning horizons that are now standard in the west. In China the authorities have come up with a large package to stimulate more consumption, recognising that China has to create more of her own demand against a background of decline in consumer demand in the USA and Europe. She also faces more competitive weaker currencies in the west beginning to switch western consumers away from Chinese goods towards home production.

So will these combined attempts work? Normally lower interest rates backed up by tax cuts and other fiscal stimulus would be enough to turn the economies. There is no doubt that doing them is better than not doing them, and they will serve to limit the depth and length of the downturn. However, there remains the outstanding issue of the strength of the banks.

Banking regulators are demanding that banks hold more capital relative to their loans than they required a couple of years ago in the boom. This means that banks will have to lend less, and charge more. It is a recipe guaranteed to make them unpopular, but also a policy which will constrain the beneficial impact of lower indicative interest rates and tax stimulus.

The next few months will see more market scrutiny of state credit risk. As several governments have decided that the way to solve the banking crisis is to transfer the dodgy debts – with or without the banks that lent the money – onto the taxpayer the focus of attention will naturally shift to the quality of government covenants. States that have borrowed too much and are borrowing too much will find the going increasingly tough, with a falling currency and difficulty in borrowing all the money they think they need at attractive rates. Some will be forced to go to the IMF for emergency loans and administered programmes of spending reduction.

Investors who have wisely been in cash during the big falls and massive turbulence of this year so far can now begin to find opportunities to buy into real assets in the better based economies, where recovery will come in due course and reward the patient investor. We still advise investors to avoid highly borrowed economies with high exposure to financial services, like the UK, where the scope for further disappointment is greater.