Nov 23, 2011

Is 2008 Comming Back Again?

If you look around there are many similarities. Should we worry about next economic downturn or market crash?

Almost one month ago markets enthusiastically cheered EU leaders’ agreement over Greek debt drama. Since then, however, the situation is not getting any better. This is obvious looking at the market indices performance over that period. S&P lost 9.85% since its 27 Oct. peak, yield on Italian, Spanish and even Belgian government bonds are persistently climbing despite ECB efforts to keep them low. There are more and more signs that we could face similar financial storm. Growing borrowing costs, freezed credit markets, higher volatility and frightened investors are common scars between present and 2008.

Current problem has no short term solution as it have been accumulated over years. Now we are witnessing painful process of deleveraging which could last longer than previously thought. The core of the entire mess is lost credibility as it appeared in 2008. This is seen with undersubscribed German bond auction few days ago. According to the latest research Japan investors prefer investing in UK gilts rather than German bunds. As to Japan it is one of the countries with highest level of debt as percentage of GDP (199%* as of 2010 according to CIA) and Standard&Poors has risen concerns over its ability to reduce it. As result is latest announcement from the rating agency for possible credit rating downgrade. This could be additional shock to already vulnerable markets.

Back to Europe France’s credit rating could also be reviewed as consequence of possible rescue plans for Belgian bank Dexia which suggest higher French involvement. Markets have been calculating eventual difficulties since July as spread between German and Belgian bonds is gradually widening since then. In addition Italian yields are stubbornly staying above crucial 7% level despite massive buybacks from European Central Bank. Up to now ECB manages to keep situation under control but rising speculation and losing investors’ confidence could undermine those efforts if market switch to panic mode.
Belgian-German 10 year bond spread

Considering all latest developments Federal Reserve recommended stress test to largest US banks. Such step in current situation is two sharp knife. Good results could strengthen investor and banking management confidence in the system but the fact that this test is undertaken now suggest growing concern for the economic conditions.

Negative news continues flooding news wires and we imperceptibly go to downward spiral. To get out of this firs and most important is returning credibility. This is the toughest part of the plan. Unfortunately Eurpean leaders still lack necessary attitude to return investors trust. In addition in most troubled countries there are no signs for growth, hence difficulties paying their obligations rise which additionally frustrates investment public. Ultimately help from countries with cash surpluses such as China is logical solution but for now there in not clear sign for action in that direction.

Definitely there are difficult times ahead but situation if still far from 2008, at least for now. Realization of consequences of destructive event such as defaulting of given (European) country has led to enormous efforts toward resolving the problems. Decisionmakers pressured from financial markets have no other choice accept moving toward stabilization. Election of new technocrat governments in South Europe prove the process is on the move. Specialists take responsibility now and crucial steps have been undertaken. Unfortunately measures for restructuring debt levels taking place now will have long term impact. Short term improvements are needed at the moment because new failure similar to Lehman Brothers this time of government scale could destroy entire financial system. The world cannot afford another financial disaster. Important decisions in Europe have to be made untill 8-9 Dec. (European leaders meeting) hopefully it is not too late.

 *Japan’s public sector debt is very high, however savings rate is relatively higher which compensate debt burden to some extent

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