This morning’s big reversal on Wall Street is merely the latest phase of the credit crunch moving to the real economy, and unfortunately there is more of it to come.
Commodities began predicting a global recession on 2 July. Since then the CRB index has fallen 20%, the LME metals index 15%, and the oil price 25%. The wheat market cracked a week ago and has now dropped 18%.
Perhaps the most dramatic manifestation of this new phase of the credit crunch is the 15% devaluation of the Australian currency in seven weeks.
It consolidated for seven months, rising from US85c to US98c as sovereign wealth fund money flowed out of US bonds and financials and into oil and commodities and commodity-based currencies, but has now returned to the low 80s very swiftly indeed as commodities have corrected and the Reserve Bank has moved decisively into an easing cycle in response to a consumer recession.
And now, finally, the gloom has spread to the sharemarket. The Dow Jones managed a peak of 11,790 on Tuesday and has now fallen 5.1% in a few days, including 3% last night.
The BHP Billiton share price actually anticipated the commodity price correction that began in July, falling 20% between mid-May and 2 July, but the bears lost conviction and the stock consolidated at $40. The wheels are now coming off again and it’s looking fragile at $37. Today is likely to be very ugly for the miners.
Commodity prices are now back to levels that are consistent with a very significant global slowdown, possibly recession. Certainly another 10% would point to a global hard landing.
In the first phase of the deleveraging of the global economy that began in August last year, there was a savage financial correction with the equity prices of all banks sliced by up to a half while the economies of Britain, US and Europe suffered most.
Australia was insulated by buoyant commodity prices, and the latest RBA commodity index shows them still going up.
That phase is now over, and the world is re-synchronising. The latest OECD interim assessment concludes that its members will struggle to record any economic growth at all over the next six to 12 months. And notwithstanding strong capital investment, Australia will not be immune.
The only question now is whether the world’s major economies experience a hard landing or a long period of stagnation.
Meanwhile the unwinding of excessive leverage is continuing which is causing continued weakness in housing markets around the world, and spasmodic eruptions of distress as over-geared corporations attempt to liquidate asset portfolios to repay debts, and in the process wipe out their equity.
In the US, the focus is on Fannie Mae and Freddie Mac which are both insolvent. As Bill Gross of Pimco points out in his newsletter published overnight, “the Treasury’s attempt to entice additional capital into Freddie and Fannie came up empty".
Gross, whose firm holds a lot of Fannie and Freddie paper, wants the US Treasury to now step in and recapitalise them, but that seems a forlorn hope. The world’s richest nation simply does not have the balance sheet to do it any more, after Bush’s tax cuts and the Iraq war.
If Fannie and Freddie collapse there is likely to be a run on the US dollar as the Asian and oil-based sovereign wealth funds withdraw, and the financial crisis itself will enter a dangerous new phase, causing further knock-on effects on the real economy.
So what will be reflected in the Australian sharemarket this morning will be a realisation that the world stands at perhaps the most dangerous point of the debt deleveraging process so far.
That doesn’t mean that a global economic hard landing is inevitable, or that the sharemarket will necessarily see new lows, but the risks of that are now greater than they have ever been.
Just look at commodity markets and the Australian dollar.
This article first appeared on Business Spectator
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