Is this the death of capitalism

We all knew where this was going to end up. It was just a matter of how long it took.

You let a bubble get too big, and suddenly it's no longer the problem of the participants alone - it's everybody's problem. And so, when it comes to paying for the global property bubble, it won't just be those who over-extended themselves to buy over-priced houses who suffer. And it won't just be the bankers who sold them the loans.

It'll be you, me, and every other mug who ever paid a penny in taxes to governments who blatantly ramped the idea of property ownership as a right. Our own government might not do anything as obvious as creating a $700bn "bad bank" like the one being proposed in the US.

But rest assured, we'll be paying for the fall-out from this for years to come...

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Who's really to blame for this crisis

It's been a hectic couple of weeks, and amid all the chaos, it's easy to lose sight of what this is all about. So let's go back to the basics.

This crisis has its roots in the actions of central banks. I think it's important to make this point very clear right now. George Bush might say there'll be plenty of time for "blame-storming" later. But funnily enough, once 'later' comes around, no one can quite remember who really was to blame, and the government ends up getting to point the finger at whoever it likes - usually the media.

Meanwhile, we're hearing about the 'death of capitalism', and even sensible people are warning that we need more regulation, over everything from City remuneration to short-selling. Now, I have no quarrel with bankers getting bonuses that actually reflect some sort of ability to manage money rather than their luck at being hired at the right stage of the economic cycle. And I'm not shedding a tear for any of the City wives who suddenly seem to have columns in all our broadsheets, bewailing the sheer hell of life without a bevy of domestic servants and carping about how charities will go short of money this year.

But regardless of how irritating all this poor-mouthing from former bankers becomes, we have to remember that their Caligula-esque pay and conditions were a symptom of the credit boom, not the cause.

Whatever is done now to bail out the system, we should remember that this credit bubble has its roots in government interference, in the form of central banking. And when we come to sort the system out, that's where we need to start, rather than with lots of tinkering around the edges.

The central bankers should have popped the property bubble

There was a rampant property bubble. The world's central bankers should have popped it before it grew too big. They didn't (although Mervyn King clearly thought that it would have been a good idea), mainly because Alan Greenspan put his hands over his eyes and said he couldn't see any bubble. He also added that, even if there was one, it would be better to clear up the mess after it had popped. It was obviously nonsense at the time, and by now hopefully everyone realises that.

Because instead of pricking it at a time when the fallout was manageable, we let it grow until harsh reality finally had to step in. Things grew so crazy that the long-term unemployed in the US were being given hundreds of thousands of dollars to buy homes on which they didn't make a single payment. This bubble stopped growing simply because it ran out of room. It just couldn't get any bigger.

Some of you might think it's too simplistic to blame central banks. But think about it for a minute. The first instinctive call of every columnist, estate agent, and business leader in the land, as they realised recession was coming, was to scream for a rate cut. That's a dramatic display of faith in the idea that whatever the problem, a quick wave of the Bank of England's magic wand would make it go away. Even now, some are still labouring under this misapprehension, even though the Fed has amply demonstrated that even slashing rates by more than half has done nothing to ease this crisis.

Because everyone thought that central banks would always be willing and able to save the economy - and the financial services industry - lenders thought they could get away with murder. All the risk ultimately lay with the government, after all. And if you take away the risk, people then do whatever they like without fear of consequences - particularly if regulators have adopted an otherwise hands-off approach.

Why we should let the market set interest rates

What's the solution? Ideally, I'd say just ditch central banks and let the market set interest rates. Central banks, regardless of how ostensibly independent they are, are instruments of the government. The government wants happy voters, and free money makes people happy. So there's always the temptation to keep the money flowing freely.

The market on the other hand, couldn't care less what voters think. One feature of the credit boom is that most people in the City and on Wall Street knew it couldn't last forever, and they had a hunch it would blow up in a very unpleasant way. But they couldn't stop playing along, because they had to compete with their peers. However, if markets set interest rates rather than governments, then arguably this mood of rising concern among the participants, would be reflected in the price of money long before things got out of hand. Anyone who had overplayed their hands would run into trouble long before they became "too big to fail".

The alternative is that we decide that banking is such a vital part of our infrastructure, that it cannot be left to the market. And if it really is the case that "banking is too important to be left to the bankers," as Roger Bootle argues in today's Telegraph, then there's no choice. We have to turn it into a utility. And just like with the water and power regulators, we need a big domineering regulator, who tells them how much profit they can make and how much they can charge us, and in return we get a government-backed banking system.

I know which option I prefer. But I suspect that by the end of this crisis, we'll be left with some half-hearted mish-mash which will simply sew the seeds for the next boom and bust.

Short-sellers aren't to blame for the banking sector's problems

Short-sellers aren't to blame for the banking sector's problems

It's time to "clean up" the City, says Gordon Brown. He's going to rush forward better rules to protect whistleblowers, apparently and crack down on "irresponsible behaviour" in the financial markets. After all, he says, "we don't want these problems occurring in the future."

The FT reports how his noble words have roused the party's left-wing. Labour MP John Cruddas said: "In the wake of casino capitalism and with the onset of recession, the state is the only means society has of protecting itself from the destructive forces of global capitalism."

It would be hilarious if it didn't make you want to weep. Bankers may well have acted as if they've been sitting in the casino during the boom years. But it was a state-owned casino, with governments as the croupiers, and central bankers behind the bar giving out free booze.

This Government built its reputation for economic "stability" on soaring house prices and nothing else. It was happy enough to point to this growth in "wealth" (not "debt") as evidence of its competence all through the boom. And the reason that banks were able to lend as freely and as stupidly as they did, was because central bankers pushed interest rates so low. And who were central bankers working for? The Government, who set the inflation target too high, at a time when prices were being pushed lower - a healthy development - across the world by globalisation.

But of course, it can't be the Government's fault. So now we have a witch-hunt against the nearest available target - short-sellers. Yet, if you really want to protect whistleblowers, you should embrace short-sellers. Here's why.

Short-selling's a risky business. When it goes right, you can make a lot of profit. But when it goes wrong (as it clearly has today, given the rapid surge in the FTSE 100 and elsewhere), you can end up owing far more than your initial stake. So it's not something to be done lightly. Unlike many 'active' fund managers, who just buy what everyone else is buying, a short-seller has to pick their targets carefully.

So when a short-seller takes an interest in a company, you can bet it's got problems, or that it's about to run into problems. It's no coincidence that the most shorted stocks in the run-up to the UK recession have included retailers, newspapers, and of course, banks.

The point is that the shorts are just taking advantage of the underlying problem. The banks made wildly irresponsible loans all through the property boom, and now that the bubble has popped, they are in serious trouble. In a perfect world without politicians, there'd be no problem with short-sellers taking advantage of that - in fact, the banks are only getting their just desserts.

The real 'spivs' behind the financial crisis

If Alex Salmond and the like want to attack 'spivs', how about the spivs who were cheerily selling young couples interest-only mortgages at six times their joint income? "Don't worry about interest rates, love, you'll be able to remortgage to a better deal in a couple of years' time. And don't worry about the capital - you can always start paying that back once you can afford it. Besides, the house'll be worth a lot more by then."

Those unlucky homeowners are now staring negative equity and rising mortgage payments square in the face, and the truth is it doesn't matter a damn to them who owns their debt, because they can't pay it anyway. Banning short-selling won't help them.

But then, all that dodgy dealing was going on back in the good times. And when times are good, no one wants to hear the warnings, or to let anyone spoil the party. And unfortunately for short-sellers, when times turn bad, most people would rather throw the smart-alecs off a cliff, than admit that maybe they got it wrong.

What the failure of Fannie and Freddie means for capitalism

I read a very pithy letter to The Telegraph the other day that made me chuckle. Referring to a story about Fannie and Freddie's nationalization, the correspondent asked: "Why didn't your headline 'World's biggest mortgage bail-out' read 'Capitalism fails'?"

Like many of the best headlines, it's witty and to the point. That almost makes it a pity that it's also completely wrong. It's also worrying that far too many other people also have this perception.

Because of course, the reality is that Fannie and Freddie were invented by the government in the first place. The reason they were able to dominate the market to the extent they did was because everyone knew they were government organisations, even when there was still some vague charade that they weren't.

In fact, all this miserable little episode in economic history tells us is this - the market will get you in the end, even if it takes 60-odd years to do so...

What the failure of Fannie and Freddie means for capitalism

As Simon Nixon points out in this week's edition of MoneyWeek (out on Friday), it was in part, the birth of Fannie and Freddie after the Great Depression in the 1930s (Freddie came later, but its roots were in that crisis) that has led directly to the current upheaval in the financial markets.

Fannie and Freddie had the implicit backing of the US government. That meant they could borrow money almost as cheaply as the government. That meant they could buy up more loans than anyone else. That's why they now dominate the US mortgage market. And that's why the government - which first created them - has now had to bring the prodigals back onto its balance sheet.

In other words, the biggest player in America's mortgage market has always been the public sector, complete with unaccountable, overpaid bosses, and dodgy book-keeping. It's only now that the majority of the population realises it.

So the 'failure' of Fannie and Freddie - or rather, the fact that the US government has finally had to admit it always owned these things - says nothing about capitalism. What it does show is that attempts by the government to buck the market are doomed to eventual failure.

It's the exact same story with attempts by central banks to set interest rates. There's a massive gap between what central banks generally say the cost of money should be, and what it actually is just now. And that's because the market has finally reasserted itself and said - this can't go on.

Why the credit crunch is 'the start of the solution', not the problem

As Leigh Skene of Lombard Street Research puts it (and I'm going to give the full quote here, because it's an unusually perceptive summary of what's going on): "The credit crunch is the start of the solution, not part of the problem. The problem is too much household debt, and it took the credit crunch to halt the hysterical borrowing / lending spiral. The crunch will be over when people understand that they should be looking to repay debt, not borrow."

That hits the nail right on the head. What needs to happen now is that people start rebuilding their savings, and companies rebuild their balance sheets. That's the way the market is pointing too. But what's the one big thing attempting to stand in the way of this vital process? That's right - the governments of the world.

Governments hate downturns. That's because voters tend to prefer good times to hard times, unsurprisingly. A government that presides over house price growth and full employment comes in for plaudits, regardless of how that growth was achieved.

The basic ideas behind how to run an economy for a long time now, have been rooted in Keynesian economics. The idea is that governments can take an active role in managing the economy through various tools, including setting the interest rate. You try to make sure the economy doesn't overheat during the good times, and in the hard times, you make money a bit more available, and maybe increase public spending too, to compensate for the downturn in the private sector and "stimulate" the economy.

There is very little the government can do to stop this downturn

Does it work? Who knows? Because while it sounds good in theory, what you actually get is a government that keeps pressing the "stimulate" button for as long as it can get away with it. The British economy has been flooded with cheap money and public spending even when times were good. It's over-inflated the economy, and left us with nothing to fall back on during the hard times.

With the coffers empty, there really is very little any government can now do to stand in the way of this downturn. But that won't stop them from trying. They won't make things any better. But as a long and grim history of price controls, currency market interventions, protectionist laws, and good old Fannie and Freddie demonstrate, they might just make things worse.

Turning to the wider markets...

The FTSE 100 closed at 5,366, down 49 points after a poor showing by banks - affected by their American counterparts' troubles - and miners. Among the risers were ITV, up 6.55% and BAE Systems, up 4.29%. For the latest stock market news and charts, click here.

In Europe, the Paris CAC closed at 4,283, down just 0.2%, and the German Xetra Dax finished down 0.4% at 6,210.

Over in the US, energy stocks were boosted by Opec's decision to restrict output, while financial shares were hit by worries about the future of Lehman. The Dow Jones closed up 38 points at 11,268; the wider S&P500 was up 0.6% to end at 1,232; and the Nasdaq Composite rose 0.9% to 2,228.

And in Asia, the Nikkei-225 was also hit by fears about Lehman, with Nomura holdings down 5.9%. The index closed at 12,102, down 2%.

Brent spot was trading at $96.17 a barrel this morning, with crude oil in New York at $101.76 a barrel. Gold spot was at around $740 an ounce; silver at $10.62 an ounce; and platinum $1,118.00 an ounce.

In the forex markets this morning, sterling was trading against the US dollar at 1.7498 and against the euro at 1.2569. The dollar was trading at 0.7191 against the euro and 107.06 against the Japanese yen.

This morning, owner of Argos and Homebase, Home Retail Group, revealed how badly it has been hit by the consumer slowdown. Second quarter same-store sales fell 5.8% at Argos, and 8.3% at Homebase in the three months to August 30th. Earlier this week, the British Retail Consortium said wider High Street sales were down 1% in August.

 

The US bail-out is a great opportunity to sell

Yesterday's breakdown in the London Stock Exchange was a fitting metaphor for the state of the entire financial system. As one problem is apparently solved so another rears its ugly head.

The Federal Reserve flew in to 'save the planet' by nationalising Fannie and Freddie, but UK investors couldn't even get in to sell their rebounding banking shares, because the LSE computers imploded at the vital moment.

As trading finally restarted, London joined markets around the world in the relief rally. But anyone who genuinely believes that Hank Paulson's move to guarantee the US housing market is the end of our woes is kidding themselves... 

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The stock market party looks a little premature

"Today's meltdown from the LSE couldn't have come at a worse time," said Sejal Patel, a London-based trader at CMC Markets. It's all a bit of a disaster for the idea of the all-singing, dancing, 24-hour trading, etc, second-biggest market in the world that on one of those days it really needed to work properly... well, er, it didn't. "Pretty poor", said Simon Denham of Capital Spreads.

Exactly. But sadly, also typical of today's financial systems. Look at the US mess. The American property market seemed to be solid enough when everyone was making loads of money. But there was a huge fault line running right through the house.

Emboldened by Fed chief Alan Greenspan and his never-ending supply of cheap money, lenders and borrowers threw common sense out of the window, dishing out vast sums to people who had no hope of repaying. As a result, the works have been completely gummed up by a near-$550bn subprime write-off, said S&P last Friday - and the end total could prove even higher still.

So the US authorities jumped to the rescue of Freddie and Fannie with taxpayers' cash. While the first-up 'expert' view is that nationalisation is good because it'll re-establish some stability, the fact that this has happened pre-election (as my colleague John Stepek pointed out yesterday (see: The Fannie and Freddie bail-out: bad news for us all)) shows just how bad things are. And now that the risks have been dumped on the public, it will be much harder to hide the losses. 

The move isn't likely to help US house prices, because it won't make life easier for millions of Americans struggling to repay mortgages. It won't reduce the massive stock of unsold American houses - 4.7m at the last count and the equivalent of over 11 months supply, roughly twice a 'stable' market level, according to the National Association of Realtors. It won't cut unemployment, which has now climbed to a five-year high of 6.1%, nor stem foreclosures, which at 2.75% of all home loans are at their highest since records began 29 years ago.

So the stock market party looks a little premature. And what's more, European traders shouldn't be cheering either - eurozone companies are facing a whole other set of problems.

Europe's companies have been spending more than they earn

One of the best barometers, eurozone consumer confidence, has nosedived within recent months. That suggests that the downturn in annual output, which shrank in the second quarter for the first time since the single currency started life 10 years ago, is the start of a lengthy trend.

And now lots of corporate concerns are building up, too. "European companies may be living on borrowed time", says Simon Kennedy at Bloomberg. "A decade of investing more than they've earned in profits has loaded corporations in the 15-nation euro area with debt, leaving them a thinner cushion than their US and Japanese counterparts as the world economy slumps".

In other words, eurozone companies have been living beyond their means. The shortfall between profits and investment for Europe's non-financial corporations rose to 4.5% of annual output last year, reckons Citigroup, compared with 3.6% for their counterparts in the US. Take out companies in Germany, where earnings still outstrip investment, and the gap swells to 6.6%.

It all means that Europe's non-financial companies are burdened with 5.3 trillion euros ($7.6 trillion) of debt, equal to about 57% of the euro-zone economy, up from 48% before the 2001 slowdown and compared with 46% in the US, according to the Federal Reserve and the European Central Bank.
Enough figures. You get the picture. As Europe's companies feel the debt pinch, so will we all. "The size of the debt imbalances makes it very difficult to envisage a strong euro-zone economy over the next year or so," says Dresdner Kleinwort's London chief economist, David Owen. "It increases the risk of recession." Deutsche Bank analysts agree, predicting that investment will shrink in 2009 for the first time in seven years, so that the eurozone's economy will grow just 0.1%.

And the cause? Too much cheap credit, of course, says Deutsche Bank. European companies are now "under attack from both sides''. Profit margins are being squeezed by slowing demand, high fuel costs and rising wages, while at the same time banks - once so keen to lend - are now trying to rebuild their own balance sheets by tightening loan standards and demanding higher interest rates.

It's no surprise that eurozone manufacturers' confidence dropped in August to its lowest level since May 2005, and that production expectations were the weakest in almost seven years.

This is a great opportunity to sell

It all adds up to a shedload more pain, with less investment and fewer jobs across Europe. As for share prices round the world, yes, they might rally for a day or two as some 'short' traders - i.e. those who had sold shares with the intention of buying back lower down - have had to close out their positions, prompting a temporary rally. That's a good opportunity to dump any retailers, property stocks or banking shares you're still holding on to.

But don't be fooled. That short-term fix across the Atlantic won't help Europe in the slightest. Nothing has changed, apart from US taxpayers being loaded up with a long-term potential mega-bill.

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After recovering from a breakdown which halted trading for more than six hours, UK shares ended Monday sharply higher, with the FTSE 100 index climbing 3.9%, 205 points, to 5,446. Banks were among the top gainers after the Fannie and Freddie takeover, while oil stocks were also higher on fears that Hurricane Ike will shut down production in the Gulf of Mexico.

In Europe, shares were also higher, with the German Xetra Dax up 2.2% to 6,263 and the French CAC 40 gaining 3.4% to 4,340.

US markets also ended higher, with the Dow Jones Industrial Average rising 290 points to 11,510 and the wider S&P 500 gaining 25 points to 1,267. The tech-heavy Nasdaq Composite gained 13 points to 2,269.

But overnight the Japanese market gave back some of yesterday's gains as traders rapidly realised that the bail-out isn't going to cure the slowing global economy. The Nikkei 225 fell 1.5% to 12,439, and in Hong Kong the Hang Seng slipped 2.2% to 20,328.

This morning Brent spot was trading at $101 a barrel, spot gold was at $799, silver at $11.97 and platinum at $1,305.

In the forex markets this morning, sterling was trading against the dollar at 1.7571 and against the euro at 1.2441. The dollar was trading at 0.7084 against the euro and 107.75 against the Japanese yen.

And this morning, the Royal Institution of Chartered Surveyors reported that house prices continued to fall in August. The number of surveyors and estate agents reporting falls exceeded those reporting rises by 81 percentage points, compared to 83 in July. Average sales per agent were down to 12.7 in the past three months, the lowest since the survey began in 1978.

The reasons behind the Fannie and Freddie bail-out

As the old saying goes, they do everything bigger in America.

Here in the UK, the government nationalised Northern Rock, a regional banking minnow whose failure wouldn't really have been very important on the scale of global finance, despite the hefty political fall-out.

Over in the US, they'll happily let their regional banks fail. Northern Rock wouldn't have stood a chance. But while the free market ethos might be applied in some instances, the US is more than happy to invoke the "too big to fail" clause when it wants to. Yesterday, the US government took over what are probably the most important financial institutions in the world at the moment, mortgage groups Fannie Mae and Freddie Mac.

The move will drag these two monsters kicking and screaming onto the government's balance sheet. According to The Telegraph, it represents a potential liability of £2,900bn. That's about £10,000 a piece for every man, woman and child in America.

Better start saving now, guys...

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The reasons behind the Fannie and Freddie bail-out

Fannie Mae and Freddie Mac don't write mortgages themselves, but they own or guarantee almost half of America's $12 trillion mortgage debt. With the housing market in freefall, that's inevitably lead to a crisis of confidence in the companies' balance sheets. Their shares have been hammered - and after this latest move, shareholders seem likely to be wiped out altogether.

But it's not the shareholders who were the problem - it was bond holders. Fannie and Freddie are still responsible for almost 70% of new mortgage loans in the States. They raised cheap money by issuing bonds, and were thus able to fund cheap mortgages for US home buyers.

Now Fannie and Freddie have always inhabited a kind of "nudge, nudge, wink, wink" financial hinterland. The US government didn't exactly say it was responsible for the two mortgage providers. But everyone knew it was. So that meant that the two companies were able to borrow money at the same rate as the US government.

That's ended recently as fears for Fannie and Freddie's future grew. All those foreign governments buying up Fannie and Freddie debt suddenly started to worry - wait a minute, maybe these guys aren't bluffing. Maybe they really won't pay back any of the loans that we've got here. And that sent them rushing for the hills. That increased the cost of borrowing for Fannie and Freddie, which in turn made US mortgages more expensive.

How much is this going to cost?

So now the US government has been forced to turn around and explicitly back Fannie and Freddie. How much is this going to cost? Well, just like Northern Rock, the answer is that nobody really knows. The US Government is crossing its fingers and hoping that things go well enough so that it might even turn a profit at a later date as it gradually runs the two behemoths down. But as Hank Paulson admits, "the ultimate cost to the taxpayer will depend on the business results... going forward."

The general consensus is that this will make things better. Ruth Lea of Arbuthnot Banking Group tells The Telegraph: "this is good news for the global economy. The Fed has clearly taken a view that to allow these two to go under would have been horrendous."

But as Paul Kedrosky points out on his Infectious Greed blog, the fact that this has happened at all shows how bad things are. The Bush administration would far rather have put this off until after the election, making it the next president's problem. The fact that they couldn't "tells you how fast and out-of-control this apple cart is."

This is turning into a dirty great game of "pass the parcel" where nobody wants to be left holding the package. The bail-outs just keep getting bigger and bigger. And every time it happens, the idea of moral hazard is dismissed as being noble, but inapplicable in this case, because the consequences of collapse are just too great.

Let's track this back. We've gone from a situation where we bailed out a single hedge fund - Long Term Capital Management (LTCM) - in 1998. That fund, which had fewer than 200 employees, was deemed too big to fail at the time. Then the tech bubble burst, and Alan Greenspan slashed interest rates to bail out Wall Street. And now the housing bubble has burst, and slashing interest rates isn't enough. So the mortgage industry is being bailed out directly.

Meanwhile, every other industry is putting the begging bowl round for subsidies. The car makers want money from the government too. How long before the retailers start asking for a hand-out (though you could argue that they've already had theirs, in the form of the tax rebate earlier this year)?

Rising interest rates, a weaker dollar - stick with gold

America's stock of bad debt has now gone as far up the tree as it can. It's all with the government and the taxpayer now. I don't know what that means for the dollar today, but it can't be good in the long run. The government's aim has to be to inflate that debt away, and forget about the consequences.

As Roben Farzad points out in BusinessWeek this week, US savers must feel absolutely sick. Their reward for resisting "the siren call" of debt is "injurious savings yields, inflationary rot, and election-season neglect, all served up with a dollop of institutional insecurity." David Gitlitz of investment adviser TrendMacrolytics tells Farzad that with the Federal Reserve rate cuts, "rates haven't been this negative" since the 1970s.

The trouble is, the world has changed, but nobody seems to get it yet. Our past decade of care-free debt accumulation has been built on the US consumer spending money borrowed from Asia, on goods made in Asia. But now the US consumer is spent out, so that cycle can't carry on.

Asian governments might still be keen to prop up the dollar, but once they realise that their exporters aren't selling anything, regardless of how weak their currencies are, they'll stop. Why lend money to these people if they're not keeping their side of the bargain and spending it in your factories? And so, to keep borrowing money and rolling over its massive debts, the US will have to pay more interest, which means higher interest rates in the long run.

We'll see what happens. But in the meantime, this bail-out gives you another good reason to be holding onto gold. Think of it as insurance: if we face inflation, it'll preserve its value. If we end up facing deflation and financial instability, it'll lose out less than other assets. I'd stick with it.

Turning to the wider markets...

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UK shares sold off sharply, with the FTSE 100 index eventually closing 2.3% down, 121 points, at 5,241. Over the week, the index dropped 7% to just 90 points above the 2 ½-year low hit in July, while the FTSE 350 mining index plunged 18% in its biggest monthly fall since 1987. Also over the week, the FTSE oil and gas index slid almost 10%. Amongst the worst hit stocks was car catalyst maker Johnson Matthey, which slipped 8.5%. Resource stocks suffered generally, with Kazakhyms and ENRC both tumbling 8% and Lonmin down 4%. In financials, Friends Provident slipped 4.4%. But Cadbury gained 2% on disposal talk.

In Europe, shares also dropped back sharply, with the German Xetra Dax easing 2.4% to 6,127 and the French CAC 40 sliding 2.5% to 4,197.

US markets were mixed, with the Dow Jones Industrial Average nudging up 33 points to 11,221 and the wider S&P 500 gaining 0.4% to 1,242, though the tech-heavy Nasdaq Composite eased 0.1% 2,256. News that unemployment had risen to 6.1%, a 5-year high, was offset by a rally in financials.

Overnight the Japanese market rallied 412 points, 3.4%, to 12,624, and in Hong Kong the Hang Seng gained 739 points, 3.7%, to 20,673.

This morning Brent spot was trading at $104, spot gold was at $815, silver at $12.57 and platinum at $1,374.

In the forex markets this morning, sterling was trading against the dollar at 1.7786 and against the euro at 1.2408. The dollar was trading at 0.6977 against the euro and 108.92 against the Japanese yen.

And in London this morning, Associated British Foods, food producer and owner of Primark, said profits will rise in the second half. The group has managed to pass through higher commodity prices to customers, while profit is also up at Primark as consumers trade down to discount shops.  

 

How house prices could fall by 75% from here - in gold terms

 

What I'm confident about is that we will get through it," said Alistair Darling yesterday about the current economic crisis.

Well, of course, we'll get through it. What I want to know is will we get through it with a currency?

It is a government's duty to provide its people with opportunity. So we must thank Alistair Darling for giving us with his wise words on Saturday what has to be the easiest money-making opportunity of the year: to sell the pound as soon as the markets opened on Monday. Not since Northern Rock a year earlier has such an obvious trade presented itself.

I said in MoneyWeek's New Year predictions for 2008 that I wouldn't rule out a sterling crisis later in the year. That moment is looking more and more likely. If it is the government's intention to devalue sterling as quickly as possible, it's hard to see how they could improve on the job they're doing.

Then again they may just be incompetent.

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The story behind the pound's devaluation

Let's start with some charts of sterling. Two pictures that each tell a thousand ugly words. The pound against the euro:



And against the dollar:



The downturn accelerated in October-November 2007, shortly after Gordon Brown announced that he would not be holding a November election. The horrid realisation must have dawned on forex traders that we had three more years of the bloke and they began hitting the sell button. But it was an orderly decline. 'He can't last three years, surely?' they thought.

Then as August began, the grim reality hit home that not only was he coming back from his holiday, but that he had no intention of resigning, despite dire Scottish election results. We had what is known as a mad rush for the exit, punctuated by a brief moment of respite as somebody won another gold medal, then downwards into the abyss.

Just as you thought you could take a breather last Saturday - perhaps watch a bit of footy or take a stroll by the river - Darling has his Road-To-Damascus-Meets-Trisha moment and onwards and downwards went the pound.

Anything that you, me or my Aunt Joan own which is denominated in sterling has lost 15% of its value in a year in currency alone.

Devaluing sterling effectively devalues the Government's debt, so you might think for a second it's deliberate. But you know deep down it isn't. It's that old Labour favourite: incompetence.

The Government can't hope to save the housing market

Do they honestly think they can save the housing market? With this new £175k stamp duty threshold, I feel sorry for anyone who is struggling to sell a property currently valued at £250k. Before you can say party political broadcast, they're going to be getting a whole load of offers at £175k, plus some cash for curtains and white goods.

Interest-free loans to help low earners to get on the housing ladder! If they're low earners, why are you trying to get them into debt? That is highly irresponsible, is it not? How will they pay that debt back? They might go on to become high earners, yes, but then they might not - and with this lot in charge of the economy the latter is more likely - and what then? This is imprudent lending - the very cause of the problem.

The cure for the property crisis

It's so simple. Why not just let prices fall to a level which people can afford? The excesses of the previous 14 years are purged and trade will begin again. That is the cure for all this: lower prices. Why do they feel the need to interfere all the time?

Interest-free loans are highly inflationary. Labour is attempting to save the housing market at the expense of the currency. It is attempting to bail out debtors, when it is their very excesses that created this mess. Why not bail out those who saved instead? Why should the prudent have had their savings value eroded by 15% in one year because of their leaders' incompetence?

Here is an update of a chart I like to show from time to time. It shows how many ounces of gold it takes to purchase the average UK house since 1930. My thanks to Tom Fischer of Herriot-Watt University for putting together. It is a wonderful chart and well worth studying.



You can see the price rises during periods of credit expansion and declines during periods of contraction. Nothing Darling does can change the inevitability of further falls. He has two choices: to simply let prices fall to the point where houses have become affordable again; or, the option he appears to have taken, which is to devalue sterling, so the falls don't seem so bad. But the net result - the real value of houses - will be the same.

If the UK really is in the worst state it's been for 60 years, as Darling says, then look at the lows set during in the 1930s and the late 1970s. One hundred or less of gold ounces to buy the average UK home. That would mean another 75% fall from here, measured in gold. Impossible? Well...

Let's just say, for the sake of argument, that sterling falls by another 20% against the dollar (I think it will be more). That will take us to $1.40. (It's been there before). Let's also say housing falls by another 25%, which would more or less mirror the falls of previous downturns. We would have an average price of £123,490. And let's say gold reaches its inflation-adjusted all-time high of around $2,000. Then you see an average UK house price of just over 85 ounces of gold. It's not so impossible.

Gold may be all over the place in dollar terms, but such is the dire state of sterling, anyone who has been buying gold with their pounds will have been doing very well. The last twelve months have seen gold go from about £330 an ounce to £460. That's a nice 40% gain in a year.

Thank you very much, Mr Darling.

Things must be bad - politicians are telling the truth

Things must be getting bad. Politicians are resorting to telling the truth.

Chancellor Alistair Darling caused something of a stir at the weekend by admitting that economic conditions are "arguably the worst they've been in 60 years." The financial crisis will be "more profound and long-lasting than people thought," he said in an interview with The Guardian.

Of course, Mr Darling does have to make the rather embarrassing admission that his earlier forecast for 2-2.5% economic growth this year, was so off-the-scale wrong as to be in the realms of surreal fantasy. So it's best if he tries to look as if he knows what he's talking about now.

And it's hardly breaking news. House prices have already fallen faster and harder than at any time since records began. Anyone who's still trying to compare this favourably to the 1990s recession is way behind the times.

But credit where credit's due. Mr Darling may finally be facing up to reality. Shame his colleagues aren't quite there yet…

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Darling is finally facing up to the harsh reality

I'm no great fan of Alistair Darling, but I have to say he came across well in his "controversial" Guardian interview at the weekend. Granted, the paper was never going to give him a hard time. But to hear a member of the Cabinet dispense with the Orwellian New Labour-speak and just admit things were awful was refreshing.

That said, I'm not daft. I suspect Mr Darling's attempts to tell it "straight" and play up the image of the hard-working but slightly naïve politician, who doesn't quite understand the world of spin, is all part of some devious Gordon Brown election strategy. You know the kind of thing I mean. "Who do you want running the country? I, prudent Gordon Brown, with my straight-talking down-to-earth team, who tell it like it is? Or smarmy professional politicians like Miliband and Cameron?" Call me cynical, but you don't survive in the Cabinet as long as Mr Darling has without knowing how to play the game.

But still, compare Mr Darling's blunt appraisal of the British economy with the defensive gibberish spouted by Hazel Blears, the communities secretary. Ms Blears told The Times that "we know things are tough and understand that people are worried. But Britain's economy is fundamentally strong."

This is just patronising rubbish, and voters are rightly irritated by it. She may not realise it, but she's effectively saying: "you're all panicking over nothing. The economy's basically fine and you're just stupid people who are taken in by all these nasty newspaper headlines."

And what does "fundamentally strong" mean? Our houses are overpriced, and our economy is dependent on people spending money they don't have on non-productive goods imported from other countries. Our banks are short of money, our government is up to its eyeballs in debt, and unemployment is rising rapidly. Where's the strength in any of that?

And Home Office minister Jacqui Smith clearly doesn't agree with Ms Blears's cheery little assessment. According to the front page of today's Telegraph, Ms Smith's department reckons that a recession will also bring with it rising crime, increased budget pressures on the police and border controls as tax revenues fall, and worsening racial tensions.

It all adds up to a grim picture for UK plc.

2 tips to help you survive the recession

But let's take a step back a minute. Yes, recessions are painful, and all the more so when you've been using borrowed money to put one off for as long as we have. But a recession doesn't have to mean complete social collapse. Believe it or not, it's a natural part of the business cycle. And just as recessions clear out a lot of the bad, unproductive investments that should never have been made, it can also be a chance to perform a similar clean-up on the household balance sheet.

Because the reality is that for most people, recession won't be a life-changing experience. Many people will lose their jobs, but many more won't. Lots of people will lose their homes, but an awful lot more won't. For the majority of people, recession will be about saving more money, and paying down debt. They won't have to worry about keeping up with the Joneses anymore, because the Joneses will be too busy trying to stay ahead of the bailiffs.

The main thing to do is to make sure you have a savings cushion for if you end up being made redundant. So you need to save up three to six months' salary as an easily accessible emergency cash pile. You should always have one of these, but needless to say they tend to get frittered away in the good times. The basic aim is to be able to meet all your living costs for long enough to find another job, if necessary. 

The other big issue many people may face is finding that when they come to renew their mortgage deal, it's got a lot more expensive. The best way to avoid this – particularly if you are coming to the end of a fixed deal soon - is to have as much equity in your house as possible. Many lenders are now looking for at least 25% before they'll give you their best deals. It may well be worth diverting investment money into paying down your mortgage if this is the case. For more on this topic, see Does a small mortgage beat a big pension?



Turning to the wider markets…

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UK shares closed the week with the FTSE 100 index advancing another 35 points, 0.6%, to 5,637, its highest level for more than two months. For the month as a whole, the index rose 4.2%, its best August since 2000. London Stock Exchange fared well with a 4% climb. Energy stocks were boosted by firmer oil prices as BP and Shell both added 1% and BG gained 3%. Banks were led higher by HBOS, up 3.4% on disposal rumours. But Enterprise Inns was the biggest blue chip faller, losing 4% on bearish broker comment.

In Europe the German Xetra Dax was flat at 6,422 and the French CAC 40 advanced 0.5% to 4,483.

US stocks closed down, with the Dow Jones Industrial Average shedding 172 points, or 1.5%, to end at 11,544 and the wider S&P 500 slid 1.4% to 1,283. The tech-heavy Nasdaq Composite added 1.8% to 2,368.

Overnight the Japanese market lost 239 points, 1.8%, to 12,834 and in Hong Kong the Hang Seng eased 321 points, 1.7% to 20,911.

This morning Brent spot was trading at $113, spot gold was at $835, silver at $13.76 and platinum at $1,459.

In the forex markets this morning, sterling was again weak, trading against the dollar at 1.8073 and against the euro at 1.2335. The dollar was trading at 0.6825 against the euro and 107.71 against the Japanese yen.

And in Europe this morning, Commerzbank has agreed to buy Dresdner bank from insurer Allianz for €9.8bn. It's Europe's biggest financial services takeover this year, reports Bloomberg, and means Commerzbank will overtake Deutsche Bank as Germany's number two banking group

UK market news 1st September 2008

HBOS Plc's Bank West Retail unit in Australia has been approached by Commonwealth Bank of Australia and National Australia Bank (Times). Associated British Foods Plc is in talks to purchase Azucarera Ebro in Spain (Mail). WPP Group Plc could consider moving its head office out of the UK (Times). Petrofac Ltd and Mubadala Petroleum Services Company LLC to establish a joint venture, Petrofac Emirates LLC in Abu Dhabi. Travel & Leisure: Stagecoach Group (+5.88% to 319.75p) reached a new 3-month relative high against the FTSE 100. British Airways Plc may consider a partnership with Alitalia (WSJ). Industrial Goods & Services: G4S Plc (+2.98% to 233.5p), Charter Plc (+2.64% to 952p) and Bunzl (+2.07% to 715p) reached a new 3-month relative high against the FTSE 100. BP bought back last Friday for cancellation 1,500,000 ordinary shares at prices between 520.75 pence and 530.50 pence per share. National Grid bought back last Friday 1,184,117 ordinary shares at a price of 717.53 pence per share. The purchased shares will be held as Treasury shares.   Latest broker recommendations Henderson price target was raised to 130p vs 110p at Citigroup. Bodycote was cut to "underperform" from "neutral" at Merrill Lynch. Imperial Energy price target was cut to 1250p vs 1500p at UBS.    NYFP.TV The Week Ahead The stories, data, and stocks that may have the greatest impact during the coming trading week.  Today’s Corporate Events (FTSE 350 universe) No major earnings expected.    Director Dealings No major transaction.      GBP / USD (15min)  FTSE 100 (15min)  techMARK (15min)  FTSE 250 (15min) next section - back to top European Markets Germany / Austria Commerzbank to buy Dresdner Bank from Allianz for appx. E9.8bln in a two steps transaction to be completed no later that the end of 2009. The transaction has potential synergies of E5bln. Allianz will have a stake of nearly 30% in the new entity. The insurance company agreed to buy Cominvest from Commerzbank, to commit up to E975m into a trust solution for specific ABS assets of Dresdner Bank. Oldenburgische Landesbank will remain with Allianz Group. The Co will cut 9,000 jobs out of about 67,000. Technology: United Internet (-1.09% to E9.96) closed at a 3-month relative low against the Dax. Retail: Arcandor (-1.64% to E5.41) reached a new 3-month relative low against the Dax. Continental was cut to "underweight" from "neutral" at Merrill Lynch. Volkswagen's commercial-vehicle unit to meet its 2H targets (WirtschaftsWoche). Daimler: Tesla Motors may be the batteries supplier for the Co's electric Smart cars (FT Deutschland). Deutsche Telekom price target was raised to E13.25 from E13 at Morgan Stanley. France Vivendi delivered 2Q adjusted net income of E757m compared to E728m consensus, EBIT of E1.24bln vs E1.23bln a year ago. Revenue reached appx. E6bln, an increase of 15.1% and of 17.4% at constant currency when compared to 2Q07. Furthermore, the Co expects to deliver 2008 profit growth similar to 2007, at constant perimeter. GDF Suez announced 1H net profit up 14% to E3.38bln compared to E2.96bln a year earlier, beating the E3.16bln consensus. The group to pay an interim dividend of E0.8 a share. Vinci reported 1H net income up to E731m (E678m consensus) compared to E614m a year ago, operating income of E1.46bln (E1.45bln expected), up 12% YoY on revenue up 15% to E15.7bln. Besides, the Co decided to pay an interim dividend of E0.52, up 11%. Altarea posted 1H net income down to E67m compared to E147.5m a year earlier. Thales and Cadbury Plc may sell their appx. 20% shares in Camelot Group Plc (Telegraph). Industrial Goods & Services: Nexans (+1.27% to E86.25) closed at a 3-month relative high against the Cac 40. Accor was cut to "sell" from "neutral" at UBS. Michelin was raised to "buy" from "neutral" at Merrill Lynch. PPR price target was raised to E86 from E84 at Lehman Brothers. Spain / Portugal / Greece Inmobiliaria Colonial posted 1H net loss of E2.4bln compared to a profit of E316m a year ago. Cintra CIT 1H net loss seen at E42.7m compared to a loss of E29m a year ago. Grupo Ferrovial could report 1H net income down to E192m compared to E756m a year ago on revenue of E6.8bln vs E7.1bln. Banks: Banco Pastor (-0.45% to E6.62) closed at a 3-month relative low against the Ibex. Construction & Materials: Sacyr Vallehermoso (-2.97% to E12.41) closed at a 3-month relative low against the Ibex. Sacyr Vallehermoso and Faes Farma 1H results expected Grupo Catalana Occidente price target was cut to E21.4 vs E27.6 at UBS.    Today’s economic events (CE time) FR 09:50: Aug F PMI Manufacturing, exp.: 45.1 GE 09:55: Aug F PMI Manufacturing, exp.: 49.9 EC 10:00: Aug F PMI Manufacturing, exp.: 47.5 UK 10:30: Jul F M4 Money Supply (MoM) UK 10:30: Jul F M4 Sterling Lending (BP) UK 10:30: Jul Net Consumer Credit, exp.: 0.8B UK 10:30: Jul Net Lending Sec. on Dwellings, exp.: 3.0B UK 10:30: Jul Mortgage Approvals, exp.: 36K UK 10:30: Aug PMI Manufacturing, exp.: 44    Indices Last Daily Change % YTD FTSE 100 5,637 35.40 -12.70 FTSE 250 9,382 110.10 -11.97 FTSE techMARK 100 1,614 14.64 -1.68 Dow Jones 11,544 -171.63 -12.98 Nasdaq 100 1,873 -42.58 -10.19 S&P 500 1,283 -17.85 -12.64 DJ Euro STOXX 50 3,366 6.21 -23.50 Dax 6,422 1.76 -20.39 Cac 40 4,483 21.11 -20.15 SMI 7,239 48.34 -14.68 Nikkei 225 12,853 -219.87 -16.04 Hang Seng 20,879 -382.75 -24.93 ASX 5,099 -36.90 -19.58  Bonds Last % Last % 10Y Gilt 4.48 US 10Y T-Note 3.81 10Y Bund 4.15 US 30Y T-Bond 4.42    EUR / USD (15min)  USD / JPY (15min)  Dax 30 (15min)  Cac 40 (15min)   Euro Stoxx 50 (15min) previous section - back to top