Almost exactly three years ago, I wrote a blog warning that there was a catastrophic financial collapse literally imminent - Severe Financial Warning. I said it would be a crisis of Biblical proportions, and indeed when a couple of weeks or so later, it did break, it was the worst Financial Crisis that Capitalism has ever experienced.
In the last few weeks, conditions in the credit markets have been tightening sharply once again. Everyone knows that the Bank Stress tests, carried out a few weeks ago, across Europe, were a sham. They failed to take into account what would happen to Banks, for example, should a sovereign debt such as Greece, Ireland, Portugal, Spain or Italy default. They did, however, contain details of just how much the Banks were exposed to such risk, and that data will have been poured over by the analysts within the Financial Community in the last week or so.
The ground seems to be being prepared to change policy. Cameron has let it be known that he is worried about his Chancellor's current policies, and is looking for an alternative to restore growth; the IMF has said that the economy is heading in the wrong direction, and that, if it continues, the Government should look to changing course, introducing tax cuts etc.; the Government's own Office For Budget Responsibility has even come out to warn about the condition of the economy; Vince Cable has called for more money printing, and the Federation of Small Businesses has called for VAT to be cut to just 5% on the construction industry, and Tourism. Similar rumblings are being heard in other European countries.
The yields on the Italian and Spanish 10 year Bonds have now gone well over 6%, a figure, which means that their debt is becoming unsustainable. At these levels other PIG economies had to be bailed out. A number of Italian Banks are known to have a considerable amount of Italian Government debt on their books.
Most market participants were looking for markets to stabilise or rise today following yesterday's recovery. But, growing concern over the Euro debt crisis, followed by the news conference given by the ECB after deciding to keep rates on hold set off an avalanche of selling that intensified towards the US close of trading. But, what could be more concerning was what happened to the price of Gold, and to Bond prices. For the last few weeks, as risk aversion has grown, money has been flowing steadily out of Equity Markets and into the Bond Markets of what are considered to be safe havens, as well as into Gold.
The Tories crow that UK interest rates are low due to their fiscal austerity measures. That is nonsense. After last year's austerity Budget, Yields on the UK 10 Year Gilt rose from being at 3.2% earlier in the year, to over 3.8% later in 2010. Despite the fact that the Tories are failing to reduce the deficit, the Yield has now fallen to just 2.6%. That is the lowest interest rate since WWII! But, in the US, with its huge debt, interest rates are even lower at 2.5%. Japan, which has an even larger debt has a yield on its 10 Year JGB of only just over 1%!!! The reason for these low rates is nothing to do with austerity or controlling debt, it has everything to do with the fact that global investors know that none of these economies are going to default on their debt, and needing to put their vast sums of money somewhere they are parking it in these Bonds.
Yet, as this massive sell-off in shares took place, not only did Gold fall, but there was no sign that any vast new sums had gone into Bonds. That could be as one market commentator said, because in such a risk averse atmosphere the money simply went into cash. But, it could also be that once again, as in 2008, we are seeing distressed Financial Institutions scrambling for liquidity. The stampede out of equities is undoubtedly motivated by fear that the austerity measures now being proposed for the US will have the same devastating effect on growth that they are having in Europe, and the consequent disastrous effect that will have on profits, and the destruction of Capital. But, then you would expect that money to go into Gold, Bonds and other similar assets. Gold did move up and down during the day suggesting a battle was going on between buyers and sellers.
It suggests to me that we could be seeing Financial Institutions selling Gold and other assets, once again not because they want to, but because they have to. If the credit markets are once again freezing up because of fear over counter party risk, as Banks throughout the globe risk seeing their loans go bad, that is precisely what you would expect to see happen. This morning, it was not just Italian banks that were being hit, British Banks saw their shares falling by 6,7 and 8%.
I suspect that in the coming days Gold will rise again, because anyone who does not need to sell it in order to raise cash will have every reason to buy it. Moreover, Trichet did say that the ECB would be engaging in what amounts to a form of money printing over the next six months. If the credit markets even remain tight, and support is required for Italy, Spain and other countries – even France's 10 Year OAT, rose today to around 4% - then with the EU politicians away on holiday, the only mechanism for intervention will be by the ECB stepping in to provide liquidity. At a time when global commodity prices continue to rise as the booming economies of the East continue to suck in large amounts for their growing production, such money printing can only result in higher inflation.
There comes a point beyond which even those buying Bonds today will begin to get cold feet, as they get little interest on their holdings, whilst their value in real terms continues to fall with inflation. In those conditions, the role of Gold as real money, and store of value reasserts itself. That is why many Central Banks have again become buyers of Gold.
For an economy like the UK that could quickly have a devastating effect. Its low interest rates are essentially built upon that influx of “hot money”. That has allowed Banks and Building Societies to keep mortgage rates down to unsustainably low levels. Without that increasingly stretched family budgets would have gone beyond breaking point. As the ITV's Tonight programme showed, there are already a large number of people in arrears on their mortgages, and repossessions have remained relatively low due to Banks exercising “forbearance”.
Credit Crunch 2 could be much worse than that of 2008, because it has now passed to the default of sovereign debt, because it now threatens to see the defaulting of the vast amount of private debt held in credit card, and other debt, and because a considerable amount of ammunition was used up in stopping the original Financial meltdown in its tracks.