Coming to a bank near you: Credit Crunch II

Real fear stalked global markets this week as ominous signs emerged that the world was heading for another Lehman-style collapse.

Investors around the world scrambled to protect their capital, pulling the brakes on investments in overseas stocks, as eurozone leaders clashed over solutions to the mountainous sovereign debt and United States debt talks stalled again.

Investors were also worried that a slump in manufacturing to below the boom-bust mark of 50 in China, the world’s second-biggest economy, meant that Asia was unable to disconnect itself from European woes. Morgan Stanley said in a research note that, rather than moving money around intra-Europe, money was fleeing Europe altogether.

Trillions were flowing out of the system, said market commentators. Ongoing rises in bond yields in Italy and Spain darkened the picture. “There is a very real possibility that the system would once again seize,” warned Jeremy Gardiner, a director of Investec Asset Management. “Credit Crunch II will be coming soon to a bank near you.”

The flight from overseas stocks in the three months to November is on par with the three months prior to the Lehman bankruptcy — before the October 2008 market crash — and the three months after the stock market crash in 1987.

Emerging markets were the biggest victim of this market reverse flow, with South Africa one of the worst-hit countries. “The European crisis is spilling into emerging markets in general,” said a London-based currency trader. “Investors are more shell-shocked than before and don’t want risk.

“They are withdrawing out of South African bonds, equities and other financial instruments as banks within the eurozone continue to deleverage to get more capital on their balance sheet. The deleveraging will hit the rand the most. This will last for a while.”

Absa Capital’s head of fixed income, commodities and currency trading, Garth Klintworth, agreed: “We’re returning to a world of return of capital as opposed to return on capital.

Investors are cashing out to offset losses on other assets such as equities. They are buying safe-haven assets such as treasuries and [German] bunds. Even gold, a safe-haven asset at a time of stress, is shedding value. The deleveraging is coming at the expense of emerging market assets, especially the rand.”

The yo-yoing rand, one of the most fluid emerging-market currencies, was forced this week to levels of R8.55 to the dollar, it’s weakest since May 18 2009, as the eurozone crisis, which has caused a dollar funding crisis, fuelled a mad rush for dollars.

“There is definitely a liquidity squeeze and the rand is the most vulnerable to this,” said Klintworth.

The local currency has depreciated almost 30% against the greenback since July — about 10% in the past month — sparking concern about its devastating effect on inflation.

The Reserve Bank warned this week of rising cost pressures as consumer price inflation quickened to 6% year on year in October. Whereas a weaker rand is good for export revenue and the country’s trade account, it is bad for import costs.

One argument is a strong rand does not bode well when global demand is so weak, because South Africa needs to stay competitive on prices. But what is bothering business and authorities is that GDP growth in China, which has become our biggest export destination, is starting to slow — its economy is not as stable as a few months ago, with housing and financial bubbles emerging. “So, South Africa is being hit from all sides,” said the currency trader.

Also, inflation is drifting higher, our current account deficit is widening and GDP growth for 2012 was revised down to 3.1% by the World Bank this week. “A weak rand is just unpalatable for a business importing goods. It’s threatening the sustainability of profit margins,” said Klintworth.

With no political solution in sight in the eurozone, there is no sign of stabilisation or any let-up in the market. German Chancellor Angela Merkel butted heads on Wednesday with European Commission president José Manuel Barroso over proposals for a joint eurobond, as a “black swan” alert was issued by a news website following Germany’s worst bond auction since the launch of the single currency in 1997.

The auction was a stark warning that the two-year-old euro crisis, which snared Ireland, Portugal, Italy, Spain and Belgium, was threatening the bloc’s paymaster, with the Bundesbank (Germany’s central bank) having to buy almost half the 10-year bonds on offer. Analysts said it was a sign that Germany, viewed as a safe place by investors in the volatile eurozone, was being engulfed by the “uncertainty” trap, because of the likelihood of it having to cover the cost of any solution to the meltdown.

While politicians bickered over how to plug the debt black hole, borrowing costs across most of Europe were spiralling uncontrollably, Greece appeared to be on the edge of default, Belgium’s Dexia bail-out was faltering and Germany’s second-biggest lender, Commerzbank, was in trouble as authorities announced that it could need an emergency capital injection.

The International Monetary Fund had to step into the fray this week, extending a flexible liquidity line to European countries that, it said, would act as “insurance against future shocks and as a short-term liquidity window to address the needs of crisis bystanders”.

Fears of a eurozone break-up or bank failure was causing anxiety in the United Kingdom, the Bank of England said this week, because it made the British financial system more vulnerable to a major shock than at any time since Lehman Brothers collapsed in 2008.

A survey conducted by the Bank between September 20 and October 21 and released this week indicated that the sovereign debt crisis in the eurozone was at the top of the worry list of 68 major firms, including banks, building societies, hedge funds and insurers. These concerns prompted the US to conduct stress tests for a global market shock on its six big banks — Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley and Wells Fargo.

“This is worse than 2008,” said Klintworth. “Then we had a corporate crisis, which then moved into banks, but governments were able to bail them out. Now sovereign balance sheets are under attack and there’s no way out.”

He said if no political solution was crafted to the “distrust playing out in the markets” the liquidity crisis would worsen.

“Currently, there is a desperate need to fund dollar assets around the world. If investors can’t find this, we’ll see this liquidity placed with the US Fed or other safe haven institutions, which won’t release these dollars into the market because of risk. This will result in a liquidation of dollar assets in Europe and around the world.

“If people can’t access dollar liquidity it will further distress the ­markets and this could result in the default or bankruptcy of financial institutions. It’s very scary.”

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