Back in the summer I wrote a couple of columns here predicting that the trouble in the debt markets was manageable, and that this would prove a good buying opportunity for shares. There were plenty of times during the summer when my heart was in my mouth, when it really did look as if the world was going to end. But fast forward to this month and my original prognosis looks surprisingly prescient. Equity markets are hitting fresh highs, commodity prices are soaring, credit markets are functioning again and banks have been offloading their stuck loans at face value. If you were just returning to work after three months off, one banker joked this week, you would wonder what all the fuss was about. Nothing has changed – apart from the fact there is a big hole where Northern Rock was.
Even so, I’m finding it hard to feel smug. That’s partly because we’re clearly not out of the woods yet. First, the technical factors that triggered the crisis haven’t yet been fully resolved. Liquidity – the ability to sell assets quickly for cash – has still not returned in full, particularly to parts of the Commercial Paper market, which is used to fund hundreds of billions of dollars of assets held in Structured Investment Vehicles. The US Treasury is trying to persuade the banks to support a $100bn bail-out of these funds – a clear sign that it is worried. If it fails, the funds may be forced to dump assets at firesale prices, triggering more market turbulence.
Second, it’s not yet clear what impact the credit crunch will have on the real economy. But there has clearly been a sharp reduction in risk appetite. Spreads – the extra yield that bonds and loans offer over US Treasuries – have risen since the summer, adding to borrowing costs throughout the economy. And banks have reined in the amounts they are willing to lend, both to consumers and businesses. That’s already affecting the US and UK housing markets as buyers are hit by higher mortgage rates and more loan applications are turned down. A slowdown in house prices looks inevitable and that will affect consumer spending.
But even if we are spared further technical shocks and the slowdown proves muted – as I believe it will – I still think the world changed over the summer. The key to that change is the growing importance of countries such as China, India, Russia and the Middle East. For as long as these countries were prepared to finance their development by keeping their exchange rates artificially low, globalisation looked like a one-way bet for the West, creating the illusion of huge wealth while disguising shifts in global economic power. People revelled in the flood of cheap goods, often bought on cheap debt financed by vast emerging-market trade surpluses.
The result was giant global imbalances that may now be starting to unwind. Emerging countries are finding it hard to hold down their exchange rates when the US is cutting rates and they are struggling to keep on top of domestic inflation. Meanwhile, many emerging countries are becoming assertive on the global economic stage. This week, Citic, the Chinese state fund, invested $1bn in Bear Stearns, a US investment bank at the heart of the credit crisis. All this suggests we may be moving to a new phase of globalisation, which will not be so much fun for the West. Global growth may continue to tick along nicely. Share prices may continue to rise. But faced with devalued currencies, rising living costs and the consequences of a decade-long debt binge, we in the West will be forced to confront the reality of our loss of economic status and come to terms with growing inequalities as the gap between the global elite and everybody else grows. On paper, we may continue to get richer. But for many, it may not feel that way.
Why we need Europe more than ever
The new EU Treaty has put Britain’s relationship with Europe back at the heart of political debate. But the real threat to Britain’s interests come not from the Treaty – which, if it makes the EU work more effectively, may be a good thing – but from the visible draining of British influence and authority in the EU. The eurosceptics may deny it, but Britain has been very successful at driving the Brussels agenda over the last decade – the current Commission is the most liberal in its history. But two things have changed over the last few months. First, Gordon Brown has been reluctant to engage with the EU, partly to satisfy the domestic political audience and partly because he has always treated his fellow EU ministers with contempt. And second, Britain’s claim to the moral high ground for its vision of light-touch regulation and open markets has taken a big knock over the last few months following the Northern Rock debacle.
Visitors to Brussels tell me this draining of UK influence is palpable, and given that there are no shortage of interventionists and protectionists willing to fill the void, it’s worrying too. Pressure is building in the EU for new rules regulating hedge funds and banks. The UK needs to engage with Brussels more than ever. If it fails to do so, the losers will be British business and the City.
Simon Nixon is executive editor of Breakingviews.com