Decoupling dies as half the globe hits crunch

Decoupling dies as half the globe hits crunch

By Ambrose Evans-Pritchard, International Business EditorLast Updated: 12:33AM GMT 12 Dec 2007

Economists are sceptical that cities such as Shanghai will be enough to offset a US slowdown
The rising economies of Asia are too small and deformed to rescue world growth as America, Britain, Australia, and Club Med face their day of debt reckoning. China may make matters worse, not better.

Read more of Ambrose Evans-Pritchard on the global economy

The seven pillars of global demand over the last year - measured by current account deficits - have been the United States ($793bn) (£388bn), Spain ($126bn), Britain ($87bn), Australian ($50bn) Italy ($48bn), Greece ($42bn), and Turkey ($34bn). Most are facing a housing bust. All are in trouble.

China cannot possibly step into the breach. Jahangir Aziz and Xiangming Li argue in a new IMF paper that China's economy is now so geared to the US and EU markets that a 1pc fall in external demand will lead to a 4.5pc slide in exports and 0.75pc fall in GDP.

Assumptions that it will weather a global shock are "likely to be wrong, perhaps dramatically."
China is indeed gobbling up iron ore, soybeans, and crude oil, but it still makes up less than 4pc of global consumption and is no longer adding to total demand. Imports have been more or less flat since April.

China is boosting GDP at the world's expense, by snatching markets with a cheap yuan. It is beggar-thy-neighbour growth.

Note that Goldman Sachs, Morgan Stanley, and Lehman Brothers, have all begun to tear up the "decoupling" manual. - the pre-crunch script assuring us that the world could get along fine as the US buckled.

"What began as a U.S.-specific shock is morphing into a global shock," said Peter Berezin, a Goldman Sachs strategist.

"There is a clear risk that some of the hot housing markets in Europe and some emerging markets will cool dramatically," he said. The bank has begun "shorting" the Chilean peso. Is the metals boom over?

In Europe, not a single junk bond has been issued since August. Spreads on Euribor - the rate used to price mortgages in Spain, France, Italy, and Ireland - reached 93 basis points last week, a new record. This is tantamount to four rate rises for homeowners.

Thomas Mayer, Europe economist for Deutsche Bank, said the European Central Bank must cut rates immediately, regardless of the lingering inflation threat.

"This could go beyond just a normal recession. It could turn into a real economy-wide crunch that we cannot stop," he said

Four months after the global credit system suffered its August heart attack, nothing has been resolved.

The US market for Asset Backed Commercial Paper (ABCP) shed another $23bn last week. The outstanding volume has fallen for 17 weeks in a row as lenders refuse to roll over loans, cutting off $393bn in funding since August.

For now, consensus has settled on the view that subprime losses will total $500bn, and crimp lending by $2 trillion as bank multiples kick into reverse.

This assumes there are no more shoes to drop. Yet shoes are dangling precariously across the global credit system. We may soon have to add the terms HELOCs and 'monoline insurers' to our crunch lexicon.

HELOCs are home equity loans, the money extracted from houses to pay bills and keep shopping. Many borrowers pushed their debt to 110pc of house values at the top of the bubble.
Moody's says 16.5pc of these loans are in arrears beyond 60 days. The HELOC market is roughly $600bn, so add another $100bn to the funeral pyre. These niches add up.

Monoliners are specialist insurers who earn fees by lending their AAA ratings to US states, counties, and cities for bond issues - the safest corner of the credit industry.

The nasty twist is that most have ventured into mortgage debt to spice returns. They now face enough losses to threaten their AAA standing.

A downgrade means that every bond bearing their guarantee must be downgraded pari passu. Pension funds and institutions will be forced to liquidate sub-AAA holdings. A fresh cascade of distress sales will ravage the $2,400bn 'muni' market.

The unthinkable now looms. Moody's said it was "somewhat likely" that top insurer MBIA would fall below the AAA capital requirement: Fitch warns of a "high probability" that CIFG Guaranty and Financial Guaranty will be placed on negative watch.

Both agencies are poised to issue verdicts. The insurers will then have a month to raise capital, no easy task after a 70pc crash in share prices.

US Treasury Secretary Hank Paulson confronts the very real danger of a credit implosion spiralling into a full-blown depression. Given the risks, he can be forgiven for pushing through a rescue plan last week that amounts to a flagrant abuse of contract law and capitalist principles.
His subprime rate freeze is undoubtedly a stinker. The reckless are bailed-out. Those who scrimped to amass a little equity get stiffed. Moral hazard runs amok. But bankruptcy settlements are always ugly. This differs only in scale.

Mr Paulson's New Deal may at least reduce systemic risk. Frozen rates concentrate losses in the lower tiers of mortgage debt, but rescue the upper tiers, which is where the threat lies for the financial system. Would free marketeers rather see the whole edifice of capitalism burned to the ground to make their point?

The root cause of this staggering debacle lies in errors made long ago by the Federal Reserve and fellow sinners. It was they who inflated the credit bubble by holding interest rates too low for too long. It was they who lulled their nations into suicidal levels of debt.

The strategic failure of a whole generation of economists, bankers, and policy-makers has been so enormous that it may now take a strong draught of socialism to save the Western democracies. We start - but may not end - with the nationalization of Northern Rock.



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