[DEBATE] : (Fwd) Capitalist crisis update

[Patrick Bond]

http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2008/06/18/cnrbs118.xml

RBS issues global stock and credit crash alert

By Ambrose Evans-Pritchard, International Business Editor

The Royal Bank of Scotland has advised clients to brace for a 
full-fledged crash in global stock and credit markets over the next 
three months as inflation paralyses the major central banks.

"A very nasty period is soon to be upon us - be prepared," said Bob 
Janjuah, the bank's credit strategist.

A report by the bank's research team warns that the S&P 500 index of 
Wall Street equities is likely to fall by more than 300 points to around 
1050 by September as "all the chickens come home to roost" from the 
excesses of the global boom, with contagion spreading across Europe and 
emerging markets.
   
Such a slide on world bourses would amount to one of the worst bear 
markets over the last century.

RBS said the iTraxx index of high-grade corporate bonds could soar to 
130/150 while the "Crossover" index of lower grade corporate bonds could 
reach 650/700 in a renewed bout of panic on the debt markets.

"I do not think I can be much blunter. If you have to be in credit, 
focus on quality, short durations, non-cyclical defensive names.

"Cash is the key safe haven. This is about not losing your money, and 
not losing your job," said Mr Janjuah, who became a City star after his 
grim warnings last year about the credit crisis proved all too accurate.

RBS expects Wall Street to rally a little further into early July before 
short-lived momentum from America's fiscal boost begins to fizzle out, 
and the delayed effects of the oil spike inflict their damage.

"Globalisation was always going to risk putting G7 bankers into a 
dangerous corner at some point. We have got to that point," he said.

US Federal Reserve and the European Central Bank both face a Hobson's 
choice as workers start to lose their jobs in earnest and lenders cut 
off credit.

The authorities cannot respond with easy money because oil and food 
costs continue to push headline inflation to levels that are unsettling 
the markets. "The ugly spoiler is that we may need to see much lower 
global growth in order to get lower inflation," he said.

"The Fed is in panic mode. The massive credibility chasms down which the 
Fed and maybe even the ECB will plummet when they fail to hike rates in 
the face of higher inflation will combine to give us a big sell-off in 
risky assets," he said.

Kit Jukes, RBS's head of debt markets, said Europe would not be immune. 
"Economic weakness is spreading and the latest data on consumer demand 
and confidence are dire. The ECB is hell-bent on raising rates.

"The political fall-out could be substantial as finance ministers from 
the weaker economies rail at the ECB. Wider spreads between the German 
Bunds and peripheral markets seem assured," he said.

Ultimately, the bank expects the oil price spike to subside as the more 
powerful force of debt deflation takes hold next year.

***

The Telegraph
Morgan Stanley warns of 'catastrophic event' as ECB fights Federal Reserve

By Ambrose Evans-Pritchard, International Business Editor
Last Updated: 1:29am BST 17/06/2008

The clash between the European Central Bank and the US Federal Reserve 
over monetary strategy is causing serious strains in the global 
financial system and could lead to a replay of Europe's exchange rate 
crisis in the 1990s, a team of bankers has warned.

"We see striking similarities between the transatlantic tensions that 
built up in the early 1990s and those that are accumulating again today. 
The outcome of the 1992 deadlock was a major currency crisis and a 
recession in Europe," said a report by Morgan Stanley's European experts.
   
Just as then, Washington has slashed rates to bail out the banks and 
prevent an economic hard-landing, while Frankfurt has stuck to its 
hawkish line - ignoring angry protests from politicians and squeals of 
pain from Europe's export industry.

Indeed, the ECB has let the de facto interest rate - Euribor - rise by 
over 100 basis points since the credit crisis began.

Just as then, the dollar has plummeted far enough to cause worldwide 
alarm. In August 1992 it fell to 1.35 against the Deutsche Mark: this 
time it has fallen even further to the equivalent of 1.25. It is 
potentially worse for Europe this time because the yen and yuan have 
also fallen to near record lows. So has sterling.

Morgan Stanley doubts that Europe's monetary union will break up under 
pressure, but it warns that corked pressures will have to find release 
one way or another.

This will most likely occur through property slumps and banking purges 
in the vulnerable countries of the Club Med region and the 
euro-satellite states of Eastern Europe.

"The tensions will not disappear into thin air. They will find fault 
lines on the periphery of Europe. Painful macro adjustments are likely 
to take place. Pegs to the euro could be questioned," said the report, 
written by Eric Chaney, Carlos Caceres, and Pasquale Diana.

The point of maximum stress could occur in coming months if the ECB 
carries out the threat this month by Jean-Claude Trichet to raise rates. 
It will be worse yet - for Europe - if the Fed backs away from expected 
tightening. "This could trigger another 'catastrophic' event," warned 
Morgan Stanley.

The markets have priced in two US rates rises later this year following 
a series of "hawkish" comments by Fed chief Ben Bernanke and other US 
officials, but this may have been a misjudgment.

An article in the Washington Post by veteran columnist Robert Novak 
suggested that Mr Bernanke is concerned that runaway oil costs will 
cause a slump in growth, viewing inflation as the lesser threat. He is 
irked by the ECB's talk of further monetary tightening at such a 
dangerous juncture.
   
The contrasting approaches in Washington and Frankfurt make some sense. 
America's flexible structure allows it to adjust quickly to shocks. 
Europe's more rigid system leaves it with "sticky" prices that take 
longer to fall back as growth slows.

Morgan Stanley says the current account deficits of Spain (10.5pc of 
GDP), Portugal (10.5pc), and Greece (14pc) would never have been able to 
reach such extreme levels before the launch of the euro.

EMU has shielded them from punishment by the markets, but this has 
allowed them to store up serious trouble. By contrast, Germany now has a 
huge surplus of 7.7pc of GDP.

The imbalances appear to be getting worse. The latest food and oil spike 
has pushed eurozone inflation to a record 3.7pc, with big variations by 
country. Spanish inflation is rising at 4.7pc even though the country is 
now in the grip of a full-blown property crash. It is still falling 
further behind Germany. The squeeze required to claw back lost 
competitiveness will be "politically unpalatable".

Morgan Stanley said the biggest risk lies in the arc of countries from 
the Baltics to the Black Sea where credit growth has been roaring at 
40pc to 50pc a year. Current account deficits have reached 23pc of GDP 
in Latvia, and 22pc in Bulgaria. In Hungary and Romania, over 55pc of 
household debt is in euros or Swiss francs.

Swedish, Austrian, Greek and Italian banks have provided much of the 
funding for the credit booms. A crunch is looming in 2009 when a wave of 
maturities fall due. "Could the funding dry up? We think it could," said 
the bank.