Difficult times – with a glimmer of light in the East?
October 25th, 2011
The Euro leaders have learned little from their crisis so far. Last week-end Mrs Merkel and Mr Sarkozy met to a public fanfare. After the much heralded meeting, they briefed the expectant press and markets that they would announce a plan by the end of the month. It had better be a good one.
Meanwhile, Belgium and France announced a very expensive bail out for Dexia, a bank which recently passed the EU stress tests without a problem. All those debates over the last year about how they would move on from bail outs, make debt holders take some of the pain, and usher in a new era of managed administrations or living wills for banks has clearly not yet come into force.
As a result the stage is still set for more trouble ahead. There is as yet no solution to the Greek debt and deficit crisis. We await decisions on how much bigger a default Greece might impose, and how much more EU lending there will be to help Greece pay the bills. We await some decision on how much money to pump into banks at risk from the sovereign debt crisis, and who will pay the bills for the new equity. We watch as the markets from time to time test out the European Central Bank’s resolve to keep the borrowing rates for Italy and Spain down to levels those states can just about afford. We continue to advise that investors avoid investments in Europe, as the banks remain very weak, the Euro lacks a decisive sovereign to take the necessary decisions, and there is still no working plan to control state deficits.
On the other side of the world there remain worries about the health of the Chinese financial system. Bears have been pointing out for some time the large debts being built up by Chinese local government. The main banks have been well controlled by the authorities as they fight inflation, but there has been substantial growth in the fringe financial institutions that are outside much of the regulatory control. It appears that the government itself is now worried about the extent of the squeeze and the stock market decline, and is indicating it wishes to buttress the main banks and encourage share prices. We think that we are now closer to the point where China will seek to take reflationary action despite the persistent price rises.
The UK has announced a second phase of quantitative easing. This is despite positive money growth and inflation of over 5% as measured by the RPI. The Bank of England itself thinks inflation will rise further before it peaks. The aim is presumably to keep gilt yields artificially low for longer, and to find ways of diverting some of the newly created money into riskier assets. The Chancellor is working on a system for credit easing, on top of the QE programme.
These remain troubled times for the major markets. We advise caution, and think the Asian economies have the most scope to sort out their difficulties and to sustain or resume decent growth, despite the west’s malaise from too much debt.
As published in Investment Week
