The Guardian ran a feature yesterday on economic comment from Davos concerning world share market sell offs. One union leader apart the vast majority of those who reoorted seemed to wholly miss the point. They seemed to be suggesting that the concern was simply with what was happening in share exchanges. Most argued these Were suffering a 'necessary correction' and once that had happened then all would be OK.
Larry Ellott in the same paper may be at least in part guilty of the same mistake: he says the sell off is serious but unless there is a transmission mechanism to real markets then it is hard to be sure that a recession will follow. So let me offer explanation as to at least threet such transmission mechanisms, whilst noting that there are more.
First, oil and other commodity price falls will deliver real bad debts to global markets for three reasons. First stocks will, for many companies, have fallen heavily in value creating liquidity crises. Second, falling margins will create long term profit concerns and so solvency issues. And third, banks in a great many countries, including the UK, have already failed to address the real scale of the bad debts they face and so are much weaker than their balance sheets suggest. This accounting weakness has to only begin a ripple effect of bad debt provisioning leading to doubts as to bank solvency for the contagion mechanism to be created.
Second, the contagion can come from currency wars as many states with a shortfall of domestic demand seek to inflate short term earnings all at the same time: China is the obvious start point for this but the rapidly developing downward pressure on prices that might result will be deeply disruptive for employment in many states, including the UK as local producers are undercut. Steel is a powerful first example. That is a powerful contagion mechanism.
Third there will be a flight to safety amongst investors. That may be to property but is much more likely to be to gilts. This is rational in the face of massive doubt about future business earnings and in particular extractive industry valuations, where current reservs are hopelessly inflated in value terms as a large proportion of the reserves on which value has been placed will have to stay in the ground if we are as a race to survive here in earth. There is, then, no short term price correction is going on: a fndamental reappraisal of value may instead, wittingly or unwittingly, be happening. That's the real explanation for market decline and the impact feeds into the first two processes and so delivers contagion.
If banking, the eextractive sector and manufacturing are all under fundamental threat at the same time then we are not seeing a blip, this is what I described as a disruptive event yesterday.
And such events are not inconsequential. They require fndamental reappraisal if market risks, operations and functions if recovery is to be possible in a reasonable time period. Failure to recognise the supignificance of the event only extends the pain. And that's the prospect that the reported view from Davos suggests we will face.
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Apologies I know this is not an advice forum, but can find nowhere else addressing this issue- what should ordinary people, with mortgagees, savings, pensions etc in the face of this?
I think the advice of RBS to head for gilts is good
“I think the advice of RBS to head for gilts is good”
In other words: increase government deficits. A pity that RBS could not have phrased its advice more more honestly.
My personal recommendation is to invest everything you have in Gold Coins.
I mean the ones with chocolate inside. That way, you’ll always be able to feed yourself and your loved ones when the world goes full zombie apocalypse.
Ann don’t panic, if the value of your house rose or fell would this cause you to sell your home?
Financial speculators will try to ride the peaks and troughs, some will win many will fail, that is the nature of capitalism and it is designed for the benefit of a few not the many.
Ordinary people should do nothing as they are likely to be fleeced by so called “financial advisers” who only have their own self interest at heart. Don’t believe anything you’re told you should do with your money in the short term without very careful thought, most “independent advice” will do you no good at all. Long term, low risk investment and savings are the only safe option at all times.
What you should do is seriously question the wisdom of such an unstable and damaging economic system – and consider supporting the development of a better alternative for the sake of your own and your families futures!
Wise words Keith
Spot on Keith -crises are often another opportunity to fleece someone.
I suppose there are always Premium Bonds now with a maximum of £50,000 I think.
Not sure what the minimum is for purchasing gilts but you’d be ripped of by a stockbroker for your pains as Keith points out. If you’ve got a house and savings+pensions coming in, you’re already in a decent place.
If you will allow a non-economist a probably ignorant, but innocent, question…. For share prices to be falling, someone has to buying them. The paper value of listed companies falls, but that is just a number. So why should it matter?
The casino players can only make profit if a price is moving: doesn’t matter in which direction. Eventually they will tire of pushing prices down, and revert to bull instead.
I wish that were all that was involved
But that is not, as I said, the real issue
This is the symptom of something much more important
@ Steve,
Yours is the view of more mainstream of economists. The neo-classicals some may say.
The heterodox take a more pragmatic and a more scientfic view. A collapse in the stock market has always meant much more than you suggest. It doesn’t matter what we think should happen in an imaginary economy when share prices collapse. What really matters is what we see that does happen in the real economy. We know only too well from previous experience what to expect.
The theory is there if you care to look it up. It’s connected to the build up of private debt in the economy which first has a stimulatory effect on asset prices. But the liabilities which banks issue when they create loans disappear relatively quickly from the economy as bank created money is taxed away in transaction after transaction. But the debts remain.
That can only be fixed by issuing more private credit. We have to accelerate the lending just to keep going. But, as Steve Keen says about China that acceleration can’t last for ever.
http://www.debtdeflation.com/blogs/2015/08/25/china-crash-you-cant-keep-accelerating-forever/
In similar vein to your argument, Richard, I came across this in a piece that JohnM provided and link to (Alt-Market.com). The author is someone who believes in some things most of us would find extreme, but many elements of their argument seem absolutely sound to me. And the insights into what’s going in in the US very useful (e.g. the detail about what’s happening to WalMart). But anyway:
‘China is the largest exporter in the world, not the largest consumer. If anything, a crash in China’s economy is only a REFLECTION of an underlying collapse in U.S. demand for Chinese goods (among others). That is to say, the mainstream dullards have it backward; a crash in China is a herald of a larger collapse in U.S. markets. A crash in China is a symptom of the greater fiscal disease in America. The U.S. is the primary cause; it is not the victim of Chinese contagion. And the crisis in the U.S. will ultimately be far worse by comparison.’
In case readers missed JohnM’s original post the full article is here, and its also well worth reading the piece at the foot of the article about the Fed (though most of us might struggle to see their actions as presaging the take over of the US by a world power).
http://www.alt-market.com/articles/2787-the-us-is-at-the-center-of-the-global-economic-meltdown
I am not sure I entirely agree
China is no a consumer: it saves 50% of GDP so to that extent it is right
The rest is invested
The problem is it is invested poorly at that rate – yields are not available
So the problem is domestic to Chinas as well – it has no idea what to do with its money now
Yes, I realised that about 30 seconds after posting the comment, Richard. I’ll think a little more before commenting in future. The author does posit some interesting points about what happens if (or should that be when) the yuan is uncoupled from the dollar which would clearly be another seriously disruptive element that links to your second point.
Yes – as MMT keeps reminding me when I read it: “it takes two (or more) to tango.”
There are some notable and cautionary words at the end of this article that are worth considering when thinking about the wisdom (or lack of) the US folliwng 30+ years of neo-liberal, free market, debt fueled consumer economics.
“It is astonishingly foolish to assume that even though the U.S. has held the title of king of global consumption share for decades, that our economy is somehow not a primary faulty part in the sputtering global economic engine. Economies are falling because demand is falling. Demand is falling because Americans are not buying. Americans are not buying because Americans are broke. Americans are broke because central bank policy has created an environment of wealth destruction. This wealth destruction in the U.S. has been ongoing, but only now is it becoming truly visible. The volatility we see in developing nations is paltry compared to the financial chaos we now face. Anyone who attempts to dismiss the dangers of a U.S. breakdown or the threat to the unprepared public is either an idiot, or they are trying to divert and distract you from reality. The coming months will undoubtedly verify this.”
Fortunately many Americans now realise this but their indoctrinated fear of thinking anything remotely “left of centre” may mean they lurch as a country even further to the right in a desperate attempt to hold onto whatever material wealth (or dream) they still have.
You mean like wearing Trump Baseball hats with the motto ‘let’s Make America Great Again.’?
Spot on again Keith. Trump is a cartoon demagogue , but a putative demagogue nonetheless and so deeply ingrained in the psyche of the American mind is the Dream that a collapse that shatters the Dream will be more than the vast majority of Americans can bear . 2008 didn’t do it , maybe 2016 will.
I would ask people to look at Cruz, not Trump.
While you may have a laugh at Trump, the high possibility that Cruz will be on top of the stack and the right wing candidate for president is high.
In almost every stand he takes, he would be the sort of candidate you would desire for a totalitarian militarist state..
SocSec = No
Expand military = yes
Abortion = No
Same sex marriage = violently no
Free healthcare = No
Using US military force to expand trade = Yes
He makes Theresa May [or may not] look like a pansy leftie
Agreed
I am becoming increasingly concerned that US politics and finance (probably here too) has been infiltrated by a breed of psychopathic individuals who are hell bent on the destruction of everything that most “normal” people consider valuable and good.
There is plenty of evidence and several academic studies that conclude many psychopaths and sociopaths are prevalent in the upper echelons of society. I have known several “global business leaders” who I would definitely put in that category based on their ability to divorce their own actions from any social conscience or personal empathy with those they have impacted.
It takes a certain type of mind to make it to the top of any large organisation and the personality traits of many such “leaders” certainly causes me huge concern.
While a bit off the wall and definitely off topic here, the implications of this on the direction of the US and other major economies is worth further consideration and research IMHO. Do we really want our world run by psychopaths?
I share your first para concern
Some thoughts: sometimes the stock market falls not because of underlying economic problems but because it is overvalued (normally it is a mixture of both problems and overvalue).
For instance the falls in the Chinese stock market come after a period when the chinese stockmarket doubled in a year. Quite clearly what is happening on the chinese stockmarket is a response to being in a bubble in 2014-15 not just the current economic poor growth. Ie. if there had not of been a bubble, there would still be falls, just not as sharp and without the knock on effects around the world
Is the situation the same in UK/US/Europe? Well we didn’t have the same bubble in 2014/15, but we have had QE which has had the explicit policy of switching money from bonds to more risky assets – shares. In other words, over the past 6 years we have been artificially inflating the stock market, or to put it another way, we’ve been deliberately overvaluing the stock market. It is no surprise that as the systematic overvaluation of stockmarkets unwinds, that unpredictable things happen.
Whether there will be a full blown stock market crash or whether this will be just a correction is essentially immaterial. The fact is that no one can predict whether it will happen, therefore it highlights the inherent policy problems with QE. Afterall QE was predicated on flowing through not just to the stock market, but also the real economy, hence making market valuations of the real economy sensible.
So the symptom for me is the idea of massive QE/Asset price inflation in conjuction with a failure to stimulate the real economy. It might ‘work’ (in some sense) for a few years, but after a while the risk is that it comes back to haunt us.
Conventional QE has not worked
But it did not cause China
And I still say – look at fundamentals
Should we expect the latest ‘correction’ to be used as a further push for TTIP to be rail-roaded through?
I should think so
Many years ago, when I first stepped onto a trading floor, I was told the most important lesson about markets:
“Ignore the noise: Equities are just a pimple on the giant buttock of the Bond market.”
Few economists – and no-one in the media – communicate the truth so clearly. One might almost think that they conspire to obfuscate it.
The debt markets are huge, dwarfing equities which are, by definition, the ‘equity tranche’ of corporate finance – the last in line for earnings after debt is serviced, first to take a haircut at the larynx when a company restructures.
It follows that the slightest quiver in the corporate debt market is visible as an embarassing eruption on the stock exchanges.
Returning to the metaphor, we have a nasty wobble in the other ‘buttock’ – Gilts, the instruments of debt for government – and this week Britain came within a whisker of a failed Gilt auction.
In plain language, no-one wants to lend us money.
That news barely made the business pages and I doubt that one in ten thousand people in the UK are aware of it.
The implications for the fiscal policies of a government which is committed to reducing debt *and failing* are alarming: and the noisy stock exchange is only an alarm bell – it is not itself the reason everyone is heading for the exits.
So what? The BoE can always step in and buy as many Gilts as the Government cares to sell.
Precisely
Yes-but the mad thing is that it has do it (at present) via the GEMMS (secondary market) at present we can’t by-pass that absurdity- so, as far as I understand it (which isn’t too far!) a failed gilt auction would have some consequence. presumably banks are buying less bonds as they are flooded with reserves and don’t need to keep as many on their balance sheets. The whole system is daft, lacks transparency; allows scavengers (bond dealers) to make unconscionable amounts of money and worse of all, disguises the fact that we have a sovereign currency and can issue the stuff!
But there is no shortage of bond buying…
This article from 2009 makes interesting reading:
http://www.telegraph.co.uk/finance/recession/5048575/Failed-gilt-auction-stokes-fears-over-UK-economy.html
And the really scary thing is that the UK came terrifyingly close to losing its (AAA) credit rating!!! Aaaaaghh!!!!
Oh…..er….
Indeed-Japan lost its credit rating and it had….wait for it…..zero impact on bond purchases.
“Returning to the metaphor, we have a nasty wobble in the other ‘buttock’ — Gilts, the instruments of debt for government — and this week Britain came within a whisker of a failed Gilt auction.
In plain language, no-one wants to lend us money.”
Not really. That’s Tory propaganda. A government that issues its currency cannot run out of money. All government spending will come back as tax if there is no saving. So it is excess saving that *causes* the deficit.
https://www.gmo.com/docs/default-source/research-and-commentary/strategies/asset-allocation/market-macro-myths-debts-deficits-and-delusions.pdf?sfvrsn=2
And of course the auctions can ‘fail’, but that’s operationally irrelevant. The alternative at that point is to leave the money on deposit at the BoE, where it can easily be ‘lent’ by BoE if needed via HM Treasury’s Ways and Means account.
UK government bond yields can only go up if the Bank of England allows them to by permitting the price of bonds to fall.
The entire conclusion you put forward follows from the premise that the bond markets can decide things.
However if it is clear to the markets that the government believes it ultimately controls the Bank of England and the understanding is that the Bank of England will prevent yields from rising, then they will not rise.
Any bond that drops below par can be purchased by the Bank of England and cancelled. That means that the private sector gets less back than it paid out for the bond.
And that is a tax. Show me a financial person that will voluntarily queue up to pay a tax and I’ll show you a unicorn.
So it matters not what the bond market thinks. It matters whether the government decides to voluntarily tie its hands.
What you put forward is a slippery slope logical fallacy.
“the noisy stock exchange is only an alarm bell — it is not itself the reason everyone is heading for the exits.”
http://mikenormaneconomics.blogspot.co.uk/2016/01/gbp-lowest-since-2010.html
“Reduced terms of trade… North Sea oil now being offered for lower prices in USD terms. Reduces the value of all financed North Sea oil inventories. Banks have to make regulatory financial adjustments.”
‘Its about price not quantity…’
I reiterate – it is the pricing of one bond tgat seemed to challenge
Others are doing just fine
@Nile,
It’s impossible for there to be a failed auction unless we adopt a very strange definition of failure.
I looked up the story in the FT and it says:
“The last failed auction occurred in 2009, when the government received bids of just £1.63bn for a £1.75bn sale of 40-year debt.”
How is this a failure? Scaling down the numbers by a few orders of magnitude I’d be happy to sell my 40 year debt of £1,750 for £1,630 now. Any offers? 🙂
As already noted, 5 year money at very low rates is not exiting markets but are selling
Long term gifts are heavily over subscribed
The claim does not stack
Nile says: “In plain language, no-one wants to lend us money.”
Not even pension funds?
In the end it’s surely the UK’s money and so if “no-one wants to lend us money” then that’s their funeral. If required, surely the government will just create a bit more…
The claim is no true
Long term gilts are being heavily suvscribed
5 year gilts are not
But the overall claim does not stack
The transmission mechanism is through the banking system. Shares and company assets are held as security on loans. This collateral enables banks to leverage their lending power. When the value of these assets falls or is even perceived to fall then banks ability to lend is affected. NPLs then increase and banks lending power collapses…
Hmmm…
I will let others address the issues in that
Watched a woman called Ann Pettifor on Al Jazeera a few minutes ago, she seemed to have some good ideas about this present crisis. What she had to say is in this article:http://www.debtonation.org/2016/01/it-is-wrong-to-blame-china-for-the-global-economys-woes/#more-6761. Have you any thoughts?
Ann is good
I know her well
She is another member of the Green New Deal group