Thursday, 2 October 2008

The sun rises as well as sets!

It has been one of those weeks where there is a sense that immense changes are afoot and that we are seeing a major turning point in history. I remember seeing the Berlin Wall falling late in 1989 and knowing that the world would be different from then on. Collectively, we have the same sense today. When the House of Representatives rejected the first bail-out plan, it just became evident that the United States had reached a central turning point in its history. What comes next is a matter of conjecture that futurists are currently debating. A more pressing question faced by a more general public is when are these horrible days going to end?

An interesting clue to the way out was placed before us last Tuesday. Circumstances forced me out of bed much earlier than could be called respectable. This gave me the chance to watch the afternoon trading in the Far East. On Monday, the US markets fell by 7%-8%. The Far East responded by falling by 4%-5% in morning trading. However, by lunch time, buyers entered the markets to leave the markets down only 2%-3% on the day. This wave of buying rolled across to Europe (FTSE 100 up 85 points on the day) and then on to America (the Dow up 485 points on the day). All in all, the losses were starting to be clawed back.

It is interesting to consider why this might be. Reports so far indicate that value investors (those who buy when good quality assets are priced at an unreasonably cheap level) were coming back to the market to snap up bargains. Indeed, Warren Buffet (the biggest value investor in the world) entered the market last week to buy $5 billion worth of equity in Goldman Sachs. As an example from the UK, the commercial bank Lloyds TSB was trading at a dividend yield of about 15% (i.e. three times the rate of retail deposit accounts) earlier in the week. If the bank’s balance sheet is as robust as it appears, if it can maintain an acceptable profitability, if it fares well in the downturn, and if it can maintain its dividend, then we can readily see why investors are considering the stock cheap and buying them.

This is all very promising. We are now seeing weak signals that indicate that the worst might be coming to an end in the financial markets. The prospects for the ‘real economy’ continue to be bleak for the next few months, and a lot of hardship has yet to be felt, but at least we can start to see a way out of the crisis. There is still scope for us to be blown off course. There is still the possibility of our political masters doing something silly, which will only prolong and deepen the downturn.

The probability of political mistakes in Europe is low and falling. Over the weekend, the UK authorities handled the collapse of Bradford and Bingley (a UK mortgage bank) and the European authorities acted decisively to shore up Fortis (a commercial bank with extensive interests in the Benelux countries and France). The monetary authorities in Europe are starting to appear to be up to the job of handling the crisis. Christine Lagarde (the French Finance Minister – France currently presides over the EU) looks particularly masterful. Even Gordon Brown has started to look as if he knows what he is doing! This appearance has substance; a model has now developed to allow the monetary authorities to manage the crisis.

The same cannot be said across the Atlantic. The House of Representatives voted against the first Bush Plan, the Senate has voted for the second Bush Plan. Perhaps this reflects that the Representatives are closer to main street USA, whilst the Senate are closer to the international partners of the US? This story still has some way to run, but one thing is clear – the credibility of the US Government as an international partner has been damaged. If the US is perceived as an unreliable partner, then it will have to pay a risk premium in future dealings. And this really brings us back to where we started – the long term impact of this crisis.

At present, the jury remains deadlocked. Events suggest that the current downturn could be of a temporary nature. It could be that the long decline over the past ten years could be reversed and the fortunes of the US improve. However, it is also possible that the US is locked in a long term decline and that the current crisis is just one more milestone on the downward path. What is becoming evident is that the weaknesses and flaws in the American system of government are increasing the likelihood of long term permanent decline. When nations across the world are seeing politicians pulling together in acts of national unity, the US still retains its partisan politics. If this hypothesis is correct, then the House of Representatives rejecting the first bail-out plan would mean that the United States had reached a central turning point in its history.

It is up to the politicians to choose whether to experience the sun rising or setting.

© The European Futures Observatory 2008

No comments: