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Panic!

Friday, 05 August 2011
     

Stock markets around the world report panic as global confidence collapses.

Poor US economic data, despite it's stimulus spending, and concerns over the real risk of US government default on it's borrowings, pushed the markets over the edge. The markets were already very uncertain in the light of the almost certain defaults across southern Europe, most recently Italy, which threatens the whole Euro-zone economy.

Silvio Berlusconi, leader of troubled Italy has declared that it's economic problems are caused by an organised attack on it's economy by speculators. This is not expected to improve the situation.

As markets opened around the world this morning, they plummeted without exception. As prices fell, investors dumped their holdings in a race to the floor, in scenes described as carnage.

The US has been wrestling with record government debt this week. There is a limit to the amount that the US government is allowed to borrow which they were due to reach about now. Once that happens the government cannot pay it's employees, suppliers, or take on any more credit, and will default on spending commitments. Democrats have been trying to reach agreement with Republicans to raise this limit, but the Republicans have been holding out for commitments to reduce the rate at which government debt is grown going forward. At the last moment an agreement was reached to allow the US government to meet it's existing commitments, but only for six months, leaving uncertainty in place. When this is next discussed, the Presidency will be up for election and the incumbent Democrat, Obama, will be up against the ropes, being dependant upon the Republican's to increase the debt limit, and being able to do nothing to prevent an unprecedented default on his watch, should they choose not to.

The US government has been spending very heavily in a bid to provide a stimulus to the economy, which is in part why it is in so much debt. However, the economy is stagnating, and tax receipts have not be increasing as expected, leaving an inevitable gap which is increasingly unsustainable. As fears grow of a default the credit rating of the country falls, and the amount they pay in interest increases. If the stimulus spending is stopped, any stimulus effect will be lost and the economy will shrink by that amount in a double-dip recession.

A double-dip in the US will impact on the rest of the world economy as it is by far the largest economy in the world.

All of this is on the back of the continuing instability in Europe, where southern Europe has spent it's way to unsustainable debt levels. They simply can't borrow any more money of anyone, and are unlikely to pay back what they have borrowed. As the whole of the Eurozone shares a single currency and central bank, this could drag the whole Eurozone economy down, even though Germany has a very strong economy. German tax payers are effectively underwriting the debts of the whole Eurozone region in order to prevent this, but this is unsustainable.

All of this causing a great deal of uncertainty and the biggest fall in stock markets around the world since the banking collapse in 2007.

One outcome might be the break up of the Eurozone economies, which will relieve the burden on Germany, allow each individual country to borrow based on their individual risk, and allow local interventions such as quantitative easing, and market adjustments such as devaluation of individual currencies, which would make some countries more competitive. William Hague, said that the UK has avoided a major debt problem itself because it turned away from the stimulus spending strategy, and made the cuts it needed to, to prevent UK debt growing at the same rate. However, as we trade heavily with both Europe and the US, we do have a vested interest in their success.

When the US job figures were released, there was a brief rally. Figures show the US economy created 117,000 jobs in July lowering the unemployment rate to 9.1%. This is better than expected and it was hopeful this would calm nerves. Confidence will remain low in the light of risks of default in Europe and the US.

"It's pretty good, it provides some temporary relief, people had been fearing the worse but its a better number and it has helped to stabilise market sentiment," said James Knightley, a senior US economist at ING.

At the end of trading, £3,000,000,000,000 had been wiped of the value of shares globally.

UPDATE: Overnight Standard and Poor have reduced the US government's credit rating from AAA to AA+ for the first time in history, citing the absence of political will in the aftermath of brinkmanship and threats of default from both the Democrats and Republicans. This will inevitably increase the interest payable on US Government debt, and worsen the outlook for the country. Meanwhile, the relative robustness of the Chinese economy and it's huge capital reserves and artificially low value have made it's currency a safe haven, as the dollar looks increasingly unstable.

It's not all bad news, although the US and Europe are in turmoil, India and China are in rapid growth, and although they are not isolated from problems in the west, they are in a much better position to deal with them. It seems the economic power is moving from the established western countries to the new dynamic and growing economies of the worlds most populous nations.

 

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