Trillion a day keeps the bears away
David Bloom, global head of foreign exchange strategy, HSBC Bank shares his views on what went wrong and the way ahead for the global economy with Mayank Singh

The decoupling of the world from the US did not make any sense, the idea that Germany could do well by exporting to China and vice-versa was a bit far-fetched as it underestimated THE power of the US economy,” says David Bloom, global head of foreign exchange strategy, HSBC Bank. In August 2007, when the US Federal Reserve started cutting interest rates, inflation grew across the globe. This was bandied as proof that the US economy did not matter, evidence that the economic and commodity cycle of the world had completely decoupled from the US.

Co-relation of financial markets
Says Bloom, “Economies can decouple but financial markets cannot. So even if analysts say that the GCC markets are sheltered from the storm it does not mean that the GCC equity markets are sheltered or that your credit markets or financial conditions are sheltered.” As the sub-prime crisis unfolded in the US, the world moved from decoupling to contagion in August 2008.

Curiously, as the meltdown progressed, the dollar strengthened and it seemed, ‘the dollar was enjoying the misery of others’. Over the last few years there was a feeling that the US was slowing and people placed their bets elsewhere. The investment philosophy was to buy into the US market for credit and not for growth. The growth bets were made in Europe and emerging markets. As the crisis grew, investors started unwinding their investments in Europe, impacting the Euro negatively. Investors had bought into high interest rate yielding instruments in the UK, but as interest rates fell to one per cent, people sold heavily.

The volatility in the global economy has made a mockery of every investment logic. “If you are planning to sell Yen and buy the Australian dollar to earn a seven per cent return a year and the currencies move at seven per cent a day, then this no longer makes sense,” says Bloom. Countries which had a big current account deficit and attracted investments by offering high interest rates like the pound sterling, the Australian dollar, New Zealand dollar and lira (Turkey) suffered heavily as investments dried up.

In contrast as companies like Fannie Mai and Freddie Mac collapsed in the US, the government stepped in, guaranteeing their debt. As a result, the paper that was junk immediately became Uncle Sam paper or guaranteed paper. Says Bloom, “Till August 2007, no one wanted to buy US credit but European equities and high interest rate yielding products. Cut to 2008 and the scenarios are completely different, you do not want to hold high interest yielding products, you do not want to buy into the global growth story, but you want government guaranteed paper.” Thus people started selling everything except the dollar leading to its rally.

Near future
As governments step in and take on debts there are growing concerns about sovereign risk. “The problem with sovereign risk is the fear that the governments have overextended themselves in order to get a recovery.”

Having said that, the US Fed’s balance sheet has gone up to $3.2trn and President elect Barack Obama is expected to inject a trillion dollars more into the economy. The biggest danger is that if these fiscal measures do not lead to the anticipated recovery then the monetisation of the debt will become an issue. “Ronald Reagan once said ‘governments never solve problems they just rearrange them,’ so what we are doing is that instead of having a deep depression, we are having a recession. The payback of this is that overtime the tax payer will have to pay back the cost burden,” says Bloom.

The Fed fund forecast is zero per cent interest rates, UK rates are falling to one per cent and ECB rates have fallen to two-and-a-half per cent. Ironically, though Central Banks interest rates around the world have plummeted, interest rate for corporate loans have actually risen. This is the result of money becoming expensive, the deteriorating credit situation and the anxieties felt by banks in lending. Says Bloom, “There is a breakdown in financial markets and because counterparties do not trust each other, central banks are being forced to become the lender of last resort and the counter party of first resort.”

No quick fix in sight
When the government let Lehman Brothers collapse people in the financial markets felt that it was the right thing to do. But as bank lending stopped in its trail everyone looked back and said that it was a mistake. Says Bloom, “The problem is that everyday we think we know what the solution is but the next day we find out that it was not the solution.”

The magnitude of the crisis has led to questions being raised about the capitalist system itself. “What is being questioned is the source of markets, if you are a risk-averse person and want to hold cash, then you would ask things like – Which currency should I hold it? Do I have sovereign risk? Which bank is safe? These are things that should be taken for granted and if we cannot take these for granted, then we have a problem in building up the rest of the system,” says Bloom.

The world also seems to be getting caught in a paradox of thrift – the fear of getting caught in an inflationary spiral is slowing consumption and corporate spending. As people save more, consumption goes down further leading to a downward spiral. “Governments are trying to snap this vicious paradox of thrift by making us believe that the money in our pocket is not as valuable, but they are finding it difficult to convince us,” says Bloom.

Despite the pessimistic scenario there is hope that in four-to-five year’s time oil prices will be higher, the fuel price inflation story will remain, there will be a secular uptrend in commodity prices and the growth story will return. “I believe all of that. The journey from here to there is full of hot pot coal, and you have to get through that to get to the other side. So 2008 will be an important year in changing the structure of the global economy” says Bloom.

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