Economic storm brewing in America
By Ambrose Evans-Pritchard
AMERICA'S STOCK markets typically start crumbling four months before
each recession, anticipating the crunch in profits. Shares then grind
relentlessly down for 10 months or so until they have on average
knocked 26 per cent off the S&P 500 index, Wall Street's listing of
So if you think the US property slump is looking scary after October's
9.7 per cent drop in new home prices, it may be time to take a little
money off the table. It has been a lucrative autumn rally, but the
four-year bull market is long in the tooth by any standards.
As we report today, the rate of insider stock sales by company
directors on both sides of the Atlantic is the highest since records
began 20 years ago, with sales outnumbering purchases by 60:1.
It makes scant difference whether your shares are on Wall Street or
the London Stock Exchange. The FTSE 100 index is a global play these
days. The lion's share of profits come from overseas, while London's
AIM market has become a bet on Chinese and Russian companies nesting
there by the dozens.
The world economy is what matters, and I don't like the smell of it.
Nor, apparently, does Hank Paulson, who made $700 million at Goldman
Sachs before taking over the US Treasury this year. He has reactivated
a crisis team with a command centre in Washington to cope with the
"systemic risk" in a market melt-down. His worry? 8,000 unregulated
hedge funds with $1.3 trillion at hand, and derivative contracts now
worth $370 trillion. "We need to be very careful here," he said.
A well-sourced article in Washington's Weekly Standard says Mr Paulson
fears a "serious crisis that would be a body-blow to the US economy".
Yes, China is booming – for now – but it accounts for just 4 per cent
of world consumption. The great US shopping extravaganza is six times
bigger, and remains the anchor of the international system. It is
slowing fast, unsurprising after 17 interest rate rises from 1 per
cent in June 2004 to the current 5.25 per cent. "Big ticket" orders
for cars, aircraft, computers and such plummeted 8.2 per cent in
Average house prices have fallen from $244,000 in April to $221,000
last month, with more violent corrections in Florida, Arizona, and New
England. Builders have warned of a "death spiral" as they slash prices
to off-load a glut of unsold homes.
[This house price index does not count unsold houses.]
The "happy handover" orthodoxy of the International Monetary Fund is
that America will escape with a shallow slowdown. Asia and Europe will
pick up the growth baton. The world will march on without missing a
Nice if you can get it. The more ominous possibility is that America
fails to recover quickly, and takes the world with it. Japan already
shows signs of stalling. Retail sales have fallen for two months. Far
from bursting back to life as expected, it is still teetering on the
edge of deflation.
France ground to a halt in the last quarter as the surging euro ate
into the country's industrial core. Airbus was humming when the euro
was worth 90 US cents. Now it must compete at $1.33, with wage costs
in euros set against delivery contracts in dollars. Currency hedges
protect for a while, then reality hits.
German industry says $1.40 is the pain limit. It is hard to see what
can stop the dollar sliding that far as funds bet on US rate cuts next
year. The yield premium that kept the currency aloft earlier this year
is about to narrow, perhaps sharply. The central banks of Asia and
Russia are sated on dollar reserves. They may not slash their US
holdings, but they are unlikely to add either. So who will fund
"The US needs a trillion dollars a year just to stand still," says
David Bloom, currency guru at HSBC. Modern financial crises have
always begun on the peripheries of global economy, setting off a chain
reaction. Mr Bloom says the seizure this time will be at the heart of
the system as the dollar buckles, pressing down on the "aorta of
So we have a world where the ageing economies of Europe and Japan are
too fragile to withstand a dollar slide, yet America needs a weak
dollar to cushion its own downturn. Meanwhile, China is holding its
currency far below equilibrium. Nobody is doing much to break this
impasse. The 1930s come to mind.
The consensus is that America will rebound quickly, averting a sticky
end. But it takes two years for rate rises to feed through an economy,
so Americans have not yet faced the worst. Nobody knows how US
households with record debt will cope with the squeeze. Borrowings
rose 8.1 per cent in 2000, 8.6 per cent in 2001, 9.7 per cent in 2002,
11.4 per cent in 2003, 11.1 per cent in 2004, 11.7 per cent in 2005,
with no let-up in 2006. Debt payments have reached an all-time high of
13.9 per cent of personal income.
Americans extracted 6 per cent of GDP from their homes last year in
equity withdrawals (ie, more debt), mostly to subsidise their
lifestyles. This game is up. Professor Nouriel Roubini from New York
University says recession is inevitable. "People have been using their
homes as their ATM machine, but many are now facing negative equity so
there will be a lot of foreclosures. As the housing recession spreads
to manufacturing, this is going to lead to a much harder landing than
The bonds markets are alert, even if equities are not. Interest rates
on 10-year Treasury bonds (4.46 per cent) have dropped below
short-term rates (5.25 per cent) for five months. This is the
"inverted yield curve" of satanic fame, flag of recession. Ignore that
at your peril.
Whatever happens, the Federal Reserve will come to the rescue. But how
soon? The Fed minutes from December 2000 show some governors fretting
about inflation long after the danger had shifted to slump. That wily
old bird Alan Greenspan silenced them, knowing in his bones that the
economy was going over a cliff.
His untested sucessor, Ben Bernanke – burdened with inflationist
baggage – does not yet have the credibility to pull off that stunt.
Whatever he really thinks, he will have to play by the book. So batten
down the hatches for a long storm.