Beware the confidence trick

It’s getting harder and harder for Australian entrepreneurs to read the signals coming out of the global and domestic economies.

Financial markets are lurching around looking for the next sugar hit of confidence, and falling sharply if they don’t get it.

The news around the Spanish bailout provided a perfect example.

Over the weekend, Spain managed to secure a massive $125 billion in loans to bail out its struggling banking sector and stave off what many saw as a potential trigger for a new credit crisis.

Initially, markets rose and bond prices fell as investors started to believe that stability could be slowly returning to Europe.

But, this morning, investors started to question the idea of the bailout and its ability to really help solve the deep-seated debt problems facing Spain. Few details have been provided about the size and conditions attached to the bailout loans, further adding to investor concerns.

There are also growing concerns that Greece – which will hold fresh elections on June 17 – is moving closer to exiting the euro zone. Indeed, reports suggest European Union officials have discussed capital controls if this was to happen, including limits on how much citizens could withdraw from ATMs.

US and European markets fell overnight and bond yields rose in Spain and Italy, which, as Alan Kohler writes today, is arguably in worse shape than Spain.

The sugar hit of confidence has already faded and it is no surprise that Australian shares slid in early trade.

There is no doubt that the woes in Europe have placed global markets in a permanent state of fear. As commentator Zachary Karabell wrote this morning, investors are still waiting for The Big One, a catastrophic event that will herald a new GFC.

“What precisely that will entail is not exactly clear, but the consensus suggests that it will make whatever happened in the months after the collapse of Lehman Brothers in the fall of 2008 seem mild by comparison,” Karabell writes.

“It will be a global synchronous implosion of the fiat money system of paper currencies unchecked by impotent central banks and governments unable to coordinate policy quickly enough to stave off collapse. Greece is seen as a possible trigger, the domino that will end up hindering Spain and then Italy from funding their debts, leading to the dissolution of the euro and generating global waves that imperil US money-market funds and Asian stability.”

The likelihood of the Big One is hard to judge. For every doomsayer you can find an economist with a counterview.

For example, while Spain, Greece, Italy and other European nations remain stuck in deep holes, ICAP economist Adam Carr argues the problems are not insurmountable – the fact that investors keep lending Spain money is pretty good evidence of that.

Of course, fear of The Big One is enough to do damage, even in Australia where we have been – and remain – reasonably well protected from the European crises.

Australia’s economy might still be humming along, and RBA governor Glenn Stevens might be telling us to take a glass-half-full view of the environment, but there are two vital links between Australia and Europe that Australian entrepreneurs should not ignore.

The first is credit. As Robert Gottliebsen argued this morning, Australia’s banks are less dependent on Europe than they were in 2009, but 30-40% of their wholesale funding comes from overseas. The longer Europe lurches from disaster to disaster, the harder it will be for Australian banks to roll over their borrowings (that is, secure new loans to keep lending to Australians) in the next two or three years.

That will flow through to business and mortgage holders – indeed, it’s the reason the banks are not passing on the full RBA rate cuts we’ve seen in the last few months. We won’t even need a Big One for the issue of constrained credit to become worse.

The second link is confidence. Just as financial markets are looking for the next sugar hit and worrying when they don’t get one, so too are Australian households and business.

This morning’s business confidence reading from NAB’s monthly survey underlines that. Business confidence fell sharply in May, with chief economist Alan Oster commenting that despite 100 basis points in official rate cuts in the six months to May, concerns about Europe still dominate.

We’ll get a reading on consumer sentiment tomorrow, but I would expect something similar. The sugar hits from good news around rates and GDP growth and unemployment is simply not lasting right now.

This morning I spoke to an entrepreneur who said he’d had three clients call up and delay big contracts. That’s exactly the sort of skittish behaviour that all business owners need to be watchful for right now.

Each time a fresh crisis emerges on the other side of the world – Spain today, Greece later this week, somewhere else next week – then customers will use the excuse to pull back, delay and generally keep their wallets shut.

Hopefully, the Big One won’t happen. Hopefully, these painful steps along the road to stability – the bailouts, the elections, the austerity measures – can lead us to a firmer footing. Hopefully, Australia’s links to a still-strong China and our exceptional economic fundamentals can get us through.

But entrepreneurs need to work hard to stay on top of the state of their customers’ minds. And they shouldn’t forget those two factors that link us to Europe: Credit and confidence.


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