Share the article
twitter-iconcopy-link-iconprint-icon
share-icon
SectionsMarch 4 2008

A wintry pessimism prevails in Davos

Brian Caplen takes the temperature of the banking community at the World Economic Forum annual meeting in Davos – and finds few optimists among the frowns.
Share the article
twitter-iconcopy-link-iconprint-icon
share-icon

No-one at Davos carried around a placard saying “the end of the world is nigh”. It was, after all, a meeting of the great minds of international finance, and their distress is couched in more erudite language such as “significant ongoing market correction” or “generalised disequilibrium”. But there was no question that the delegates at this year’s annual meeting of the World Economic Forum in the Swiss ski resort were distinctly rattled.

Scattered among the doomsayers were a number of optimists who believe that, in the current crisis, the leading emerging markets are so strong and so decoupled from the US economy that they can act as torchbearers and save the global economy from darkness.

But for the most part the heavyweights of the conference were pessimistic, viewing the current crisis as serious and requiring a determined policy response – such as IMF managing director Dominique Strauss-Kahn’s unprecedented call for fiscal measures (traditionally the IMF has been fiscally conservative), a statement which was, in turn, described by former US treasury secretary Larry Summers as a “mildly historic event”.

Lessons from Japan

In general, however, Davos raised more questions than answers. The current US situation was compared to Japan’s economy in the 1990s with falls in housing prices, high levels of household debt and problems in the banking sector, a predicament that took Japanese policymakers years to find a cure for.

No-one at this stage can be certain that the current US policy of fiscal stimulus and cuts in interest rates, while more proactive than Japan’s, will provide all the answers, especially as the huge global imbalances (China’s current account surplus compared with the US deficit) show no signs of abating. Politicians are starting to get impatient, and French finance minister Christine Lagarde reiterated her president Nicolas Sarkozy’s call for a less restrictive monetary policy from the European Central Bank, something that ECB president Jean-Claude Trichet has so far resisted.

With solutions in short supply, attention has been focused on the relative sideshows of sovereign wealth funds and private equity, which produce sniping between different interest groups but do not impact rapidly at the global macro level.

One of the bleakest assessments of the crisis came from the new CEO of Merrill Lynch, John Thain, during a panel on the global economic outlook. “The problem was caused by low interest rates, high liquidity and lax lending standards which has led to losses on mortgages and mortgage related securities,” he said. “But underlying the mortgages are home prices. Home prices in the US were down 7% year on year in 2007 and almost certainly are going to continue to decline.

“Inventories of unsold homes are up and, as we look out into 2008, there will continue to be downward pressure on home prices that will continue to put downward pressure on all mortgage-related securities. You have seen the assumptions on cumulative losses and home price deterioration get continually worse.”

Mr Thain said that the situation would continue to deteriorate with credit problems moving into other areas, such as credit cards, autos and home equity loans. The impact would be felt around the globe, he said.

Scott Freidheim, co-chief administrative officer of Lehman Brothers, also thinks that the impact will be global. “It’s misguided to think that emerging countries are isolated and will not be affected,” he said. “The turmoil will hamper growth in the developed countries and the emerging markets, where we may see both a tougher export environment and an inflationary pressure-led rise in social protest.”

But when it comes to a policy response, Mr Summers’ believes international policymakers are behind the curve. “Attention needs to be paid to the international dimension,” he said. “There has not been a willingness to grapple seriously with the consequences of a US adjustment.

“If the US is to run a substantially smaller current account deficit, there must be a deterioration in the current account position of other countries in the world. How that is to take place, where the demand is going to come from, is a subject that has not – to put it mildly – been at the top of the international dialogue. There is much more enthusiasm for US adjustment than there is for accepting its consequences.”

Capital flow

These sentiments were reiterated by Merrill Lynch vice-chairman William McDonough, former president of the Federal Reserve Bank of New York, speaking to The Banker.

“If you look at the flow of capital in the world you have countries exporting much more capital than is in their interest to do so,” he said. “It indicates an economy (and certainly this is the case for China) that is too much geared towards the export sector and not enough towards improving the lot of their people by producing more goods and services for local consumption.

“The good thing about the global imbalances is that the major importer of capital, the US – 6.5% of GDP, $850bn or so in 2006 – simply cannot continue in this role. We cannot afford, as a nation with a very serious savings problem, to continue to import other people’s capital and to continue the cost of debt servicing. The savings ratio has three parts: the government, which is in chronic fiscal deficit; the household sector, which used to save 7% of income and now saves -1%; the only savings that are taking place at all are by the private business sector, which should be investing. It’s a 10-year project to get this fiscal situation under control.”

Mr McDonough points to the underfunding of social security and medicare systems in the US as major problems that have to be tackled.

Interestingly, the reserves in these systems are low yielding US treasuries, which makes it all the more curious when US commentators – Larry Summers included – object to sovereign wealth funds whose aim is to preserve wealth for future generations in their own countries.

Mr Summers described the actions of sovereign wealth funds as akin to “cross-border nationalisation” and imagined scenarios in which political pressure could be applied by such funds as shareholders to produce non-market outcomes, for example by persuading an international bank to provide regional development finance that it would not otherwise provide. But no reference was made to the benefits to the US and the UK of establishing their own sovereign wealth funds.

Norwegian finance minister Kristin Halvorsen, Russia’s deputy prime minister and finance minister Aleksey Kudrin, Muhammad S Al Jasser, vice-governor of the Saudi Arabian Monetary Authority, and Bader M Al Sa’ad, managing director of Kuwait Investment Authority, were among those who defended the role of the sovereign wealth funds as being responsible shareholders taking a long-term view. Sometimes the funds have even eschewed voting rights to allay political fears, such as when the Chinese government took a 9.9% stake in US private equity firm Blackstone.

With sovereign wealth funds in the limelight, private equity – the usual whipping boy for everything that is bad in the world – took a back seat. “For the first time in about five years, we haven’t been the object of as much attention and scorn as we have in previous years,” said David Rubenstein, managing director of Carlyle Group, in the private equity session at Davos. “The sovereign wealth funds have got most of that this year. I’m very happy to be put on the sidelines.”

But, ultimately, sovereign wealth funds will go into private equity themselves, Mr Rubenstein noted, by recruiting out of the big firms and setting up funds in their own countries. This would be only a cog in the macro process of boosting domestic investment and demand in the emerging markets, and it will not come soon.

Meanwhile, politicians, if they want to be re-elected, will opt for quicker solutions.

Price stability

“We are going to go through a period of ‘back to reality’ and it will not be about smoke and mirrors or click versus brick,” said Ms Lagarde. “The rates [prices] for energy resources and raw materials are an expression of this and we will see it percolating throughout the service sector. Having said that, I think we will need a combination of monetary policy and fiscal policy [to resolve the crisis].”

She said she hoped Mr Trichet would not only look at price stability, but would also be sensitive to comments coming from across Europe, not just from France, that monetary policy must also boost growth. Ms Lagarde said that Mr Sarkozy was keen for there to be a forum where political bodies could discuss monetary policy.

There is a feeling among European politicians that the ECB should more closely follow the example of the Federal Reserve in pursuing a monetary policy that fosters growth as well as keeping inflation in check. But Mr Trichet, in an interview with The Banker, played down the differences between the two central banks (see interview: ‘Transparency is the key word for what we are doing now’).

With such a sharp divergence of opinion among international policy makers, it is impossible not to conclude that it will take further crises to concentrate minds. In the meantime, bankers will have to cope with the turbulence.

Was this article helpful?

Thank you for your feedback!