China’s plans to pump more money into its flagging economy (well, flagging by Chinese standards at least) sent many stock markets around the world higher yesterday. But even as stocks jumped, the news from the “real” economy was becoming grimmer by the minute. In Britain, surveys showed retail sales falling and house sales slowing even more. But that news paled into insignificance compared to the turmoil in the US…
More cutbacks and job losses are on the horizon
British retail sales last month fell year-on-year for the first time since April 2005. The drop was just 0.1%, but it’s a sign of things to come. As Helen Dickinson of KPMG put it: “A fall in the value of total sales is extremely rare. There is no doubt retailers will need to resort to heavy discounting.” The news from the housing market was no better. The Royal Institution of Chartered Surveyors reported that the average number of sales completed per surveyor has fallen to 10.9 over the past three months. That’s down by 53.6% on a year ago. It’s also the worst figure since records began in 1978. London was worse still, with just an average 6.4 sales over the three months. The one piece of good news – for now – was that raw material prices are collapsing. Input prices fell by 5.6% month-on-month in October, while output prices fell by 1%. They are still well ahead of last year (up 6.8% and 13.8% respectively) but with commodity prices continuing to fall, inflation is likely to follow suit. Of course, the collapse in demand also means that profit margins are going to come under pressure. Even if producers manage to pass on some of the earlier rises in raw material costs to their customers, as Paul Dales at Capital Economics put it, “the deepening recession will force retailers to absorb higher costs in their margins.” Pressure on margins means cutbacks and more job losses.
Credit card lending conditions are set to tighten further in the US
So it was a pretty grim day in the UK. But across the Atlantic, things were a lot worse. Electronics retailer Circuit City filed for bankruptcy protection. It’s the largest retailer in the US to file so far in this crisis. The company has 700 stores and 40,000 staff. It will shut 175 of these and cut 17% of its staff in the next two months. What’s the big problem? A lack of credit of course. The company makes about 75% of its sales on credit cards, but as chief financial officer Bruce Besanko put it, “Over the past several months, consumers have been unable to borrow funds through credit cards, let alone home equity loans.” It wasn’t the only big company suffering. Parcel delivery group DHL is shutting down its domestic express delivery service in the US. That move will see 9,500 people lose their jobs. Deutsche Post, DHL’s parent company, has decided that the business has simply become too expensive to keep. Of course, both of these events have a silver lining for somebody. Circuit City’s main competitor Best Buy will benefit, while FedEx and UPS will be happy to see DHL’s US business shrink. But for the time being, they’ll be competing for slices of a pie that’s also shrinking.
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Credit card lending conditions are likely to get even tighter. American Express has been given permission by the Federal Reserve to become a commercial bank. The credit card giant made the move to gain access to funds from the central bank. But loan losses are rising sharply, which means they need to keep more money aside. And at the same time, sales of bonds backed by credit card payments have frozen up – as Bloomberg reports, “October marked the first month since 1993 that card companies were unable to sell bonds backed by customer payments.” So Amex needs to be able to sell them to the Fed instead. That’s not great news for the American taxpayer. But they probably won’t kick up a fuss. Because they’ll be too busy wondering where the money to bail out insurance giant AIG is coming from. The Fed has now extended its “existing credit line to AIG to a staggering $150bn” says FT Alphaville. That’s from the original $85bn. As Alphaville points out, AIG is now essentially part of the US government’s bail-out apparatus. The money is going towards propping up the credit default swap (CDS) contracts (insurance against bonds defaulting) which were written by AIG on various risky assets, such as CDOs (the packages of dodgy loans that have caused so much trouble). AIG is now planning to start buying these CDOs back off the banks too.
Investors start to worry that the US won’t repay its debts
As Randall W Forsyth points out in Barron’s, all these bail-outs don’t come for free. “What happens if the requests begin to strain the credit line of the world’s most creditworthy borrower, the US government itself?” Forsyth points out that the yield curve is getting steeper. All that means is that the yield on short-term US government bonds is much lower than that on long-term US government bonds. This would normally suggest that investors expect a recovery in the future, as economic growth picks back up again and interest rates start to rise to more normal levels. But at the same time, the cost of insuring the US Treasury’s debt via CDS has also risen sharply, which in short, means that investors are getting worried that the US may not be able to repay its debt. This suggests that investors are demanding a much higher payback on long-term government bonds not because they expect a recovery, but because they suspect that the US government will try to inflate its way out of trouble, or even – unthinkable though it may be – default on its debt. “All of which,” as Forsyth puts it, “suggests America’s credit line has its limits.” We may well find out what they are before this crisis is over. Regular MoneyWeek contributor, Tim Price, has more on government bonds and inflation in the latest edition of his Price Report newsletter.
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