The 'great debt unwind' continues apace

Central banks are slashing base rates across Europe in a renewed, desperate attempt to minimise the impact of the unstoppable descent into slump. Their combined efforts can be compared to joining hands in a line to confront an avalanche of snow head-on. You just know what the result will be.

Many, but not all, commentators and analysts have expressed surprise and shock at the unexpectedly large 1.5% cut made by the previously ultra-cautious UK Monetary Policy Committee which is supposed to be motivated by keeping inflation under control. Many of those amazed by the size of the cut simply haven’t cottoned on to the historically unprecedented depth and breadth of the global crisis.

With Britain predicted to be the worst hit by a shrinking economy of the developed countries – the extinction of companies like Royal Worcester & Spode, one of Britain's oldest pottery makers, with its roots stretching back to 1751 is significant – the fear is now that inflation will turn into its opposite. Falling prices may suit consumers but with raw materials' prices volatile and sales falling, many companies will see their margins squeezed even further and be forced out of business.

Indebted consumers with pressures on jobs and housing growing daily, have been forced to turn their back on many goods. New car sales in the UK slumped by 23% last month - in effect, the biggest fall for 17 years. In the US and Europe things could hardly be worse as car sales have declined dramatically – falling as much as 20% on last year. GM, Ford, Chrysler, Peugeot, Fiat, Tata owned Jaguar Landrover and BMW, Honda and Bentley are all in big trouble, closing plants and laying off workers.

Despite appeals and exhortations from Chancellor Alistair Darling, the likelihood that the deep cut in the base interest rate will be passed on in full to individuals and small businesses is close to zero. There are some who are beginning to realise what is going on. Alex Allen, chief investment officer at fund of hedge funds boutique Eddington Capital Management, believes that equities are set for a four- to five-month rally before a "cataclysmic crash" next year.

"At the edges where markets are liquid we've been willing to call the bottom. We're bullish on equities for the next four to five months and then we expect to see the final cataclysmic downleg," he said. "Equities will go to at least 50% below where they are now. It's going to be as bad as 1929," he said. "Equity markets are extremely expensive."

But what is going on now puts 1929 in the shade. In the few years following the Wall Street crash, share markets fell by 90% of their pre-crash value. The scale of today’s burst balloons of credit and debt are unimaginably much greater. A month ago the assets of failed global investment bank Lehman Brothers were auctioned off. The loss in value gives just a hint of what is to come. The auction set a price for Lehman bonds of 8.625 cents on every dollar. Financial firms that sold credit default swaps, therefore, left owing 91.375 cents on the dollar. And this is just a small part of the big, much bigger picture.

Warnings from those who are in the know should be taken seriously. “This time next year, Obama euphoria will be crushed under the weight of the unfolding economic and market meltdown,” says Albert Edwards, analyst at Société Générale. “The crushing weight of the ‘Great Debt Unwind’ has only just begun.” Throwing that weight off and re-establishing the economic and financial systems on a new, not-for-profit foundation is the urgent task at hand.

Gerry Gold
Economics editor