Fear Is Overdone

Fear, doom, gloom are all the rage. Every commentator wants to outdo the last with ever worsening predictions of financial meltdown, spreading out around the world. Certainly in the UK where the government has no funds available to support the consumer market, or in Europe where inflation is running well out of control, the pain level is rising. The UK is also beset by a government which has no comprehension as to what to do to help the banking system to cope. Yet again see John Redwood’s Diary for the best explanation.

In the USA housing market, however signs are that the end of the tunnel is at least visible. Real Estate prices are falling. But conversely the numbers of sales are starting to rise, (LINK) stimulated by the lower prices, and the government’s ensuring that loans are still available – although minimum deposits now have to be taken unlike before the crisis when deposit free mortgages were too easily available. The trend of buyers returning to the market can only get better as prices continue heading south, and that means that prices will in time find a floor.

As long as borrowers have made a deposit, they don’t walk away from their mortgages, this crisis has shown, while with no deposit to lose, many are finding that walking away is the best way out of their financial predicaments, leaving the losses for the lender, or the people who underwrote the risk. We are half way through the second year of the US mortgage crisis. The numbers defaulting are still rising, and the pain spreading – see HERE , but so too are the signs of an eventual end to the crisis starting to appear.

The US economy is also being helped by a falling dollar making employing Americans again more attractive. The rising oil price has quadrupled the cost of shipping goods over from China, and rising wages and costs in China are also making goods that were seen as dirt cheap five years ago, come up in price to the point where many find it is worth manufacturing in the USA once more. Quality control is easier, and fast response to customer requests again become possible. Service quality can maintain better prices in many cases.

The troubles of adjusting to the high oil price, and the credit crunch are far from over in the US, but the end of the crisis appears to be at least taking shape. Elsewhere the troubles are only just starting.

European banks are carrying huge writedowns on their books from underwriting the American housing market. And now the European property markets are starting to hit the same kind of troubles that first hit the USA last year.

Europe is now descending into a crisis which has yet to be dealt with, and from which the political fall-out could be considerable. While the dollar is falling with interest rates on the floor and easing the stresses in the system, in the EU, the Euro is rising and interest rates are being set to counter the inflation which is threatening. America is taking a risk on inflation with low interest rates, but these can be adjusted upwards later once the credit crunch is under control. In Europe the panic is just starting to set in, and the same kind of adjustments will be needed as are happening in the USA.

The problem in Europe is the Euro, which just keeps on rising, and the ECB which sees its primary role as a guardian against inflation. It has no mandate to ensure the economy keeps rolling, and cannot coordinate low interest rates with boosts in government spending to see off recessions, as there is no Central government in the euro zone.

It would be easier for each European country (including Ireland) to fight the recession separately with their own currency. They could allow the level of their currency to fall, set interest rates to boost economic activity and boost government spending until growth returned, as the US is doing. Inside the euro zone they are simply stuck, unable to manoeuvre to meet the growing crisis.

Italy for example cannot compete internationally, and is heading for the rocks. Germany is strong but is unlikely to continue indefinitely to hold up all the other countries inside the euro zone floundering with high inflation and high indebtedness. It is likely that the financial crisis that started in America will end up as a political crisis in Europe. In the long term that too can only be good for Europe’s economy, as the imbalances within the Euro will have to be unwound at some point.

It would be better for the Euro to be unwound now, before the imbalances get any worse, and so that Europe too can refind the floor as the coming economic storm hits. The governments of the weaker countries like Italy, Spain and Greece will no doubt cling on to the Euro hoping that Germany will carry on securing their debts for them. It must be in Germany that the Euro will finally crack.

Downturns are healthy for economies in the end of the day. People make the adjustments they should have been making beforehand, but did not do, as they were busy and flush. When the pain bites, then people move and make the improvements and adjustments that create the next phase of economic growth. The end of the Euro and the EU of 27 countries locked together in semi-paralysis will be just one of those necessary adjustments. A hard economic blow that knocks some sense into Europe would be the best possible thing that could happen. Morgan Stanley Link.

For a lighter look at the financial crisis see The Subprime Primer. It explains in an amusing way, how America persuaded trusting/gullible Europeans to carry its risks.

The Tap Blog is a collective of like-minded researchers and writers who’ve joined forces to distribute information and voice opinions avoided by the world’s media.

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