Chuck Prince is the chief executive of Citigroup, one of the world’s biggest financial institutions. He is an extremely rich man. Whether he is a wise man, though, is an entirely different matter.
I say this purely on the basis of an interview Prince gave to the Financial Times less than three weeks ago. He summarily dismissed the notion that there was a whole heap of trouble brewing in the financial markets as a result of excessive and reckless borrowing. Citigroup, one of the biggest providers of finance for private equity deals, would certainly not be drawing in its horns.
“When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing,” Prince said. That was on July 10.
Last week the dancing stopped. Why? Because this was not the equivalent of a ball in a Jane Austen novel, but a crazed St Vitus dance of uncontrolled wildness.
The markets can’t say they weren’t warned. Only a few weeks ago the Bank for International Settlements (BIS) — the central bank’s central bank — warned that markets were starting to believe their own hype: “There seems to be a natural tendency in markets for past successes to lead to more risk taking, more leverage, more funding, higher prices, more collateral and, in turn, more risk taking.”
In such an environment, the BIS noted, every fall in asset prices is seen as a buying opportunity, until the point is reached when prices are so out of kilter with fundamentals that they have only one way to go: down. The bull market has been predicated on the notion that risks were minimal, credit was cheap and problems such as the sub-prime lending scandal were localised.
Last week was a belated wake-up call to the markets. They woke up after the orgy to find the dream world had vanished, only to be replaced by a dreary reality in which central banks have taken away the extra-strength hooch that got the party going, to find that there is a distinction between the interest rate for safe investments and some of the more rococo products dreamt up by Wall Street, and to discover a bunch of financial institutions nursing considerable losses.
The reason share prices tanked last week was not because of the news from the United States housing market — poor though that was — but because the markets rightly fear that we are in credit crunch territory, where banks either reduce the amount they are willing to lend or make that lending so expensive it deters borrowers.
Given that the markets have been relying on bountiful, if not unlimited, credit to fund their takeovers and buyouts, that means trouble.
Of course, the trouble may blow over. But, unless the central banks ride to the rescue with interest rate cuts, I doubt it. The banks are now wary of validating the risky activities of the financial sector by providing them with easy credit.
And though market turbulence may mean interest rates in the US and United Kingdom have peaked, it would be grotesquely irresponsible for policy makers to contemplate bailing on the hedge funds and investment banks.
Instead of working out ways of re-inflating the bubble, policy makers should be considering ways of tackling some of the more deep-seated problems that recent events highlighted. The twin engines of the UK economy, for example, are the housing market and the City. Last week saw demand for home loans falling and the biggest drop in the FTSE 100 in five years.
Should the property market go belly up at the same time as a credit crunch causes financial retrenchment, what can the UK look to as a source of growth? The government? That seems hardly likely, given that borrowing is already set to be about £30billion this year and spending growth is to be pared back in the next few months. Manufacturing? A shrunken relic of its former self. The creative industries? Please don’t insult my intelligence.
Last week’s assessment of the state of the world economy from the International Monetary Fund showed growth this year is now expected to be 5,2% — higher than the 4,9% estimated a few months ago. Yet more than half the expansion is the result of growth in three developing countries: China, India and Russia. These are countries that are growing rich on the export of low-cost manufacturing, services and commodities.
What’s more, the trade surpluses they are building up are providing them with enormous financial clout. The growth of sovereign funds is the result of countries such as China and Russia having money to burn. They are looking for investment opportunities in the West, and where they once concentrated on amassing financial assets they are now looking to take stakes in Western companies.
Some countries find this trend disturbing. Washington is far from relaxed about US industries falling into the hands of the Russians and the Chinese, fearing that both countries may be playing a long strategic game. Likewise the French and the Germans.
What is happening, though, is the direct and inevitable consequence of a highly unbalanced global economy, where debtor countries such as the UK and the US rely on the largesse of creditor countries such as China to fund their profligate lifestyles.
While this takes place below the radar, through the purchase of Treasury bills or by flows of hot money into the City, the arrangement seems perfect. Once the true vulnerability of the debtor countries is exposed by the purchase of real assets though– companies that voters have heard of — things are inclined to get a bit nastier. This tends to increase political tension and pressure for protectionism.
Not yet, though, in the UK. If the price is right, anything is for sale. You would be forgiven for finding this faintly ironic. The first thing Tony Blair did on becoming Labour leader in 1994 was to scrap Clause 4, the party’s commitment to public ownership. Since then, it has been an article of faith that there will be no going back to the bad old days of nationalisation. Now, though, it appears that there is no problem about British assets being owned by the state, provided it is not our own state. — Â