Market Turmoil
May 28th, 2010
It’s been another troubled week in world markets. Volatility has been extreme. Markets have plunged on further fears of the Euro crisis spreading into the banks. Then markets have rallied strongly on news that China may not sell her European government bond holdings.
Underlying all these gyrations is restriction of credit. The rapidly advancing economies of Asia, led by the giants of India and China, are having to rein in their excessive money growth to start to curb inflation. Western banks are suspicious of one another again, as they worry about how much lower grade sovereign debt each bank might hold. Australia has pushed up interest rates. The UK has an inflation problem which seems to rule out any further quantitative easing and reminds people that the next move in official rates will be up. The Euro zone still does not have a satisfactory way of controlling deficits and deciding how much money to print to reflect current economic conditions.
In other words, all the huge imbalances in the world economy which we have often talked about are still out there and causing strains. That is why this year we have been running much more balanced portfolios, and have been avoiding specialist UK and European equity investment.
The problem of overstretched sovereign borrowers is in some ways worse than overstretched private sector and banking borrowers. The sovereigns have already stood behind or bailed out the private sector. Who bails out the sovereigns? The only answer is less highly borrowed sovereigns, who can be reluctant to do so. Attention turns to the EU in the cases of countries like Portugal, Greece and Spain, and to the IMF for any government in financial trouble. We are very conscious that there are limits to how much even the IMF can take on, and limits to how far solvent states will go to underwrite imprudent countries.
There are some certainties in all this. Asia is better financed and growing faster than Euroland. All equity markets are vulnerable to tighter money and to further banking troubles. This is a time to be careful and to watch the response of authorities world wide as they struggle with the growing gaps between surplus and deficit countries and between exporters and importers. Meanwhile in the currency markets there remains a race to the bottom, as many countries favour devaluation to get out of debt and balance of payments difficulties. It’s temporarily a race the Euro is winning.
