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Focusing on the central problems
As crisis settles into global slowdown, looking to non-financial markets doesn't calm the nerves.
- By Tony Jackson, Financial Times
- Published: 23:45 October 21, 2008
As the hullabaloo of the banking crisis fades, it seems increasingly to have been a kind of distraction from the wider topic. Investors are now once more contemplating the non-financial corporate world. It is not a pretty sight.
As an apparently minor sign of distress, take the Baltic Dry Index, which measures bulk shipping rates. It has halved this month, and is down more than 90 per cent from its peak in May.
In part, this is a simple recession story, to do with dwindling demand for iron ore and the like. Yet that is not the whole story.
Demand for coffee, one presumes, has been steadier. However, the price received by growers in Indonesia, the world's biggest producer, has dropped some 40 per cent in two months.
The main reason, apparently, is that shippers cannot get trade credit. This is the time-honoured procedure where exporters get a guarantee of payment from a bank, for a fee, until the end customer settles.
The system of export credits applies to iron ore as it does to coffee. Take it away, and trade is crippled.
With luck, this particular bit of financial plumbing will be unblocked along with the rest. But it must be recalled that rather a lot of the world's big banks are now part-owned by governments.
Their first priority, one assumes, is to get taxpayers' money back. Politically, they will also be keen to stimulate lending to domestic business. How far they will want to devote taxpayers' equity to far-off trade finance is another question.
Structural changes
It is also part of a wider issue. As Ian Harnett of Absolute Strategy Research points out, the entire model of global industry over the past 20 years has been based on the premise of cheap, abundant credit. Take that away, and what happens, for instance, to outsourcing? Indeed, what happens to globalisation?
There are also financial pressures nearer home. Last week, the UK's Association of Corporate Treasurers warned of the strangling effect of seizure in the money markets. Short of radical action, it said, "it is quite possible we will witness the collapse of a solvent but illiquid company".
All this has not been lost on the equity markets. The yield on European non-financial stocks, according to Citigroup, is now higher than that on a basket of European sovereign bonds. This is unprecedented, at least in the 45 years Citi has looked at the data.
For the entire European market including financials, Merrill Lynch says, the yield is now the highest since 1975. Put those together, and the market plainly expects sweeping dividend cuts.
Merrill calculates that in the three last recessions dividends were only cut by 8 per cent on average, against falls in earnings of 35-40 per cent. And bank dividends only fell by 7 per cent.
This time, as a result of the bank rescue, some big banks may be paying no dividends at all for years. And bank pay-outs have until now made up nearly a quarter of the European total.
To return to our wider theme, or a variant of it. According to the latest Merrill Lynch fund managers' survey, the danger least preying on global investors' minds at present is geopolitical risk.
They might perhaps ponder the fact that derivatives markets are now pricing in some quite startling probabilities of sovereign default: 90 per cent for Pakistan, 80 per cent for the Ukraine and so forth.
The idea of the already tottering Pakistani state defaulting is not reassuring. The fact that China apparently offered last week to underwrite Pakistan's overseas debt payments is not necessarily comforting either.
As for the ex-Soviet satellites in central and eastern Europe, Hungary and the Ukraine were last week lining up support from the European Central Bank and the International Monetary Fund. That is somewhat better news but not necessarily the end of the story. The worry is that these countries are fairly recent adherents to capitalism - as witnessed by the suicidal tendency of Hungarians to finance their mortgages in hard currencies such as the Swiss franc. The way things are going, that adherence may be sorely tested.
If that seems minor in the scheme of things, it relates back to the central issue. The global economy that evolved after the collapse of the Soviet Union is glued together by credit, at both the corporate and sovereign level. In a worst case, it now risks coming unstuck.
One final non-cheering thought on the equity markets from Ian Harnett. Experience suggests that in crises such as these, bank rescues come some time before the market touches bottom.
In the horrible UK bear market of 1973 to 1974, the bank rescue - the so-called "lifeboat" - came at the end of 1973. The market did not turn until a year later, with the collapse of Burmah Oil.
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