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G7 needs to realise world economic order has changed
When we're frightened, the gap between myth and reality gets wider. Spurred on by fear, we want to think those in charge know what they're doing. We tell ourselves situation has to improve.
- By Liam Halligan, The Telegraph Group Limited, London 2008
- Published: 23:28 October 13, 2008
When we're frightened, the gap between myth and reality gets wider. Spurred on by fear, we want to think those in charge know what they're doing. We tell ourselves situation has to improve.
Rather than relying on hope, though, or even delusion, what we really need is hard talk. Only no-nonsense discussion will close the myth-reality gap. And until it does close, our policy actions will be too weak and this crisis will roll on and on.
We've just endured the worst five-day run in the history of global stock markets. Share prices have gone completely haywire. On Friday, the FTSE100 lost 10 per cent in the first seven minutes of trading - as £80 billion of shareholder value was wiped-out at a rate of £200 million per second.
Nothing explains such falls except blind fear, as the credit screw tightened further. Over the past year, sub-prime has driven shares in our leading companies down 40 per cent. But last week alone, they fell 21 per cent.
Let me say at the outset, there was much to commend in the UK's bailout package. I've long argued that the American government's plan of buying up banks' "toxic" assets wouldn't work - or would only amount to "round one" - and direct re-capitalisation was needed.
That's what the UK has now delivered. Last week's plan, for all its flaws, was conceptually correct. Given the immense pressure they're under, those involved deserve credit.
Some £25 billion - and another £25 billion if needed - will be injected into our commercial banks to restore core capital ratios. In return, banks must accept a dilution, with preference shares going to the Treasury. The authorities took the even bolder step of providing a £250 billion guarantee to try to reactivate the wholesale inter-bank markets.
But for all this reassuring reality, we're still indulging in some dangerous myths. The first is that cash alone can unblock the wholesale money markets. Since "sub-prime" emerged as a serious problem in August 2007, some $500 billion of defaulted mortgage-backed securities have been "written down" by banks around the world. There could be three times' as much still to come.
Despite the bailout and the co-ordinated 0.5 per cent (50 basis point) cut in base rates by central banks in the UK, US and Eurozone, inter-bank rates in London barely budged. That's extremely bad news.
But is it surprising? Wholesale money markets won't start operating freely again until all banks are forced - by law if necessary - to declare the entire extent of their exposure to sub-prime, default swaps and any other loss-making positions.
Another myth is that the West can get out of this alone. G7 leaders are this weekend trying to agree on "urgent and immediate action". But the most important players aren't there - because they haven't been invited.
What the world now needs is stability. That will stem from governments standing behind massively over-exposed Western banks while more collapse, others prevail, and the system is reconfigured. That requires deep, deep reserves - and, after decades of profligacy, the Western coffers look bare.
For all its posturing, the G7 has only 20 per cent of the world's currency reserves. Four emerging markets - Brazil, Russia, India and China - account for 40 per cent. And then there's the Middle East.
The penny needs to drop. Governments need to work together to restore financial stability. So why are our leaders currently holed up in Washington pretending the world hasn't changed?
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