Another Dark Day for Global Markets as Policy Interventions Fail to Reassure

Grim Milestones

The Dow Jones Industrial Average yesterday closed below the 9000 mark for the first time since 2003, the seventh straight day that it has closed lower. Closing at 8579.19, it was off by 678.91 points. The index is now 39% down on last year's all-time 14164.53 record. This kind of pattern has not been seen since the extended declines of the 1930s and 1970s. During those periods there were rallies, but these were regularly erased. A common definition of a market crash is a 20% fall in two days. The Dow has come close to this, although it has not quite replicated the one-day 22.6% fall in 1987, or the back-to-back 12.8% and 11.7% falls in 1929. The sell-off is being spurred on by growing fears over the health of the financial system and the rapidly-worsening economic outlook. Out of nowhere a household-name bank or corporation can be brought to its knees by a liquidity crisis, and investors are panicked by the faintest rumour. General Motors' stock fell 31% yesterday after Standard & Poor's suggested a debt rating downgrade could be on the way. The stock falls are decimating the wealth of households and businesses and will inevitably hit their consumption and investment.

Asian equity markets followed Wall Street down as the coordinated monetary policy action implemented yesterday failed to prevent a further tumble in shares amid fears of a global recession. In China, the Shanghai Composite was down 3.6%, while Australia's S&P/ASX 200 registered a huge 8.3% one-day fall, its biggest ever. The Japanese Nikkei index shed 11.4%—the sharpest decline in 20 years—as confidence was further battered by the collapse of insurer Yamato Life Insurance with US$2.7 billion of debt. The panic reverberated across the region with the MSCI index of Asia-Pacific stocks ex-Japan falling 3.5% to its lowest level since June 2005. Central banks across the region again moved to pump liquidity into the financial system led by the Bank of Japan (BoJ), which injected a further US$35.5 billion, in the 18th consecutive day of liquidity-boosting open market operations. The Reserve Bank of India pumped US$8.2 billion into the financial system by lowering the reserve requirement ratio for commercial banks to 7.5%, as both the stock market and the exchange rate weakened sharply. Still high inflation in India has so far inhibited interest rate cuts. In Indonesia, authorities enacted a series of regulatory measures aimed at stabilising the local bourse as trade in shares was suspended indefinitely. The leading index has fallen by its biggest margin in two decades over the past three days. The convulsions in Asian markets, despite the limited risk of systemic crisis in the financial system, highlight the shift of the risk profile to the real economy. With Asian growth still highly dependent on external demand generated largely in the G3 economies, the prospect of a more protracted and severe downturn is increasing on an almost daily basis. At the time of writing there is no let-up in Europe either, with the United Kingdom's FTSE-100 down almost 8% and below the psychological 4000 threshold. The French and German markets are faring even worse, the former down almost 9% and the latter almost 10%.

There is a silver lining of sorts for major economies when one looks at the simultaneous falls on the commodity markets. Light sweet crude for November delivery was down US$4.00 to US$82.59 on the New York Mercantile Exchange earlier today, its lowest level since October 2007 and 44% off the 11 July record of US$147.27. Slower economic growth will mean slower demand, and news that OPEC may cut production hardly stirred the market yesterday amid scepticism that this will be enough. The fall is helping ease price pressures and made the rate cut decisions easier earlier this week. The oil market trends do, however, spell problems for major oil exporters. Countries such as Venezuela, Iran, Nigeria, Saudi Arabia, Libya and Russia will suddenly find the going much more difficult. Many of these have shaky economies outside of the oil sector, and will need to slash their fiscal plans if the price continues to fall. The global credit crunch is also hindering oil producers' efforts to raise capital and fund new investment.

Government Interventions Increase Sense of Crisis

In these circumstances, policy-makers can find themselves stuck between a rock and a hard place. They have to react to the situation with decisive and bold measures, but in doing so they risk fuelling market fears that there is worse to come. If they are talking about further intervention in the banking sector, does this mean they are not telling us something? This seemed to be the logic in investors' minds yesterday after news that the U.S. government is considering taking equity stakes in leading banks (see below for more). The coordinated interest-rate cuts by central banks in North America and Europe earlier in the week were welcome, but investors tended to see them as confirmation that economic growth is indeed slumping.

In terms of the U.S. Treasury's next moves, it is known to be considering a new two-pronged effort to provide additional props for the financial sector. The first would see guarantees for billions of dollars of bank debt, while the second may involve temporary insurance for all U.S. deposits. These dramatic interventions would come on top of numerous measures introduced over recent months, including the US$700 billion troubled assets repurchase programme. The deposit insurance measure would aim to stem the withdrawals of cash from financial institutions, particularly smaller regional banks that investors fear would not be propped up by the government. There is also growing expectation that officials now gathering in Washington DC for IMF/World Bank meetings will come up with coordinated measures. According to the Wall Street Journal the United Kingdom is pushing the bank debt guarantee approach strongly as a joint G7 effort. The guarantees would be granted in return for ownership stakes.

Outlook and Implications

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