WISE MONEY

The International Monetary Fund says the global financial system remains the problem area for the economic recovery.In a new report, the IMF predicts a gradual improvement in the financial system, but adds that there is a substantial risk of further problems.

The warning is not one of panic, but they are clearly nervous.

The IMF says that in the last six months there has been a setback to financial stability, which may affect the recovery from global recession.

That has been highlighted by the continuing turmoil in European financial markets. In these markets, government debt has combined with the weak banks to undermine stability.

Jose Vinals, the senior IMF official responsible for the report, said that some of the most vulnerable countries have taken important steps to deal with government debt and problem banks.

Greece is moving “forcefully” and Ireland is taking “very decisive actions”, he said.  So he expects “things to get better not worse”, he said.

Nonetheless, the financial system remains fragile, the report warns.

There is also a warning that some developing countries could be destabilised by large financial inflows, as investors seek higher returns in fast-growing economies. That is particularly a concern in Asia and Latin America.

One important theme underlying this report is the continued divergence between the unconvincing economic recovery in rich countries and the more robust performance of many developing nations.

Low interest rates in the developed world, intended to spur recovery, mean there may be more money to be made in Asia and Latin America.

The IMF points out that quite modest shifts by rich country investors could have a large impact on developing-world financial markets.

Such inflows have the potential to lead to financial instability.

The price of gold hit a record high yesterday, with analysts giving a number of reasons for its rise.Both the price of the actual metal and the price for buying it at a future date rose more than 2% to $1,274.75 an ounce.

It was the biggest one day gain for the commodity in four months.

One of the factors spurring investors is gold’s traditional role as a so-called “safe-haven” investment at times of economic uncertainty.

On the physical market, demand for both bullion and jewellery has risen ahead of the seasonal Indian wedding period and the Hindu religious festivals that begin in September.

Another driver is more technical – gold is priced in dollars, and any fall in the dollar makes it cheaper to buyers using other currencies.

The dollar has fallen across a range of currencies, driven down by a range of factors.

Its most remarked upon slide has been against the Japanese yen. It is trading at a 15-year low against that currency.

The price of gold has risen 16% so far this year.

The World Gold Council’s last report on the gold market predicted that continuing strong demand from jewellery buyers in the two fast developing markets of India and China, would help keep the price high.

Global banking stocks are on the rise again today as regulators announced details of the Basel III accord.Proposals include raising the minimum core Tier 1 capital level from 2 to 4.5 per cent with a subsequent 2.5 per cent require as a buffer against future shocks, which is to act in a counter cyclical manner in the sense that Banks will set aside the money when the going is good.

Large British banks already meet the capital benchmarks comfortably, RBS, Lloyds Barclays and HSBC all have core Tier one ratios of around 9-10%, but the announcement will spark a fresh round of capital raising in the worldwide banking sector.

Deutsche Bank has announced it will tap shareholders for cash to pay for it’s acquisition of retail bank Deutsche Postbank and to bolster its own capital position, expect this to be the first of many over the next few months.

The announcement has signalled risk-on (at least for today) and Sterling is gaining against the safe haven currencies of the Dollar and Yen.

The gain in the Pound today look likely to be short lived, with the Chancellors controversial budget cuts sparking union discontent and threats of co-ordinated strike action across the country.

George Osborne detailed further reductions in the welfare budget, amounting to £4 Billion, but he gave no details on where the axe may fall (this is on top of the £11 Billion of cuts announced in the emergency budget in June).

The strikes would see disruption to the economy on a scale not seen for many decades and will be heavily Sterling negative – this will be on top of the effect on the Pound of a reduction in growth levels when spending cuts begin to take effect.

Central bank governors and senior regulators yesterday agreed new rules designed to prevent a repeat of the recent global financial crisis.
At a meeting in the Swiss city of Basle, they agreed a deal requiring banks to hold more capital in reserve.

European Central Bank chief Jean-Claude Trichet said the new regulations – called Basel III – were “a fundamental strengthening of global capital standards”.

“The transition arrangements will enable banks to meet the new standards while supporting the economic recovery,” he added.

In a joint statement, the US Federal Reserve and other major US banking regulators said the deal “provides for a more stable banking system that is less prone to excessive risk-taking”.

Low levels of capital relative to assets were a major factor in the recent global financial crisis.

The agreement, due to come into effect from 2013 and be phased in over several years, still needs to be ratified by the heads of government of the G20 group of nations at their summit in November.

The amount of common equity – the tier one capital for absorbing losses – that banks have to hold will rise from 2% of their loans and investments to 7%.

The 7% includes a 2.5% “conservation buffer” to protect banks against periods of difficulty or stress.

If banks’ capital ratios fall below 7%, regulators may place restrictions on their ability to pay dividends and bonuses.

The biggest banks – whose failure could bring down the entire financial system – will have to hold even more capital.

But regulators say that if these new restrictions are phased in over several years they will not undermine economic recovery.

The new requirement should prove little problem for UK banks, as it is in fact lower than the 8-9% ratio currently held by them. It is also well below the 10% level that was being pushed for by the UK, the US and Switzerland.

The updated rules will mean some banks will need to raise a lot more money from shareholders.

The rules may have the effect of limiting lending, at least in the short term, as most banks – particularly those in Europe – have too little capital for the loans they have already made.

On Friday, the Dow Jones fell by as much as 120 points after annualised growth in gross domestic product (GDP) was found to have slowed from 3.7% in the first quarter to 2.4% in the second.That came on the back of growth of 5% in the final three months of 2009. The US was initially thought to have grown by 2.7% in the first quarter but that was revised upwards on a day of surprises for economists.

The US Commerce Department also revised downwards GDP figures all the way back to the beginning of 2007.

The second-quarter slowdown led economists to question whether the US might be poised to enter a period of negative growth later in the year, leading to a much-feared double-dip recession.

The Dow Jones fell sharply after the release of the GDP data before recovering ground to settle down 40.72 at 10,426.44 in lunchtime trading. Economists had predicted second-quarter growth of 2.5pc, but their disappointment was compounded by the revised data for the first three months of 2010.

The biggest concern in the City was the size of the downward revisions to previous years’ growth. In 2009 the economy was previously estimated to have declined by 2.4%, but the figure was revised to a drop of 2.6%.

The disappointing growth numbers were compounded by the International Monetary Fund’s (IMF) annual report on the US economy. The IMF said there may be a need for the Obama administration to increase the amount of fiscal stimulus in order to boost the recovery, warning the “outlook remains uncertain”.

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Analysts at the French financial group AXA see a serious likelihood that the eurozone will break in half or disintegrate, dismissing Europe’s £623bn rescue package for Club Med debtors as a stop gap measure that misdiagnoses the problem.
“The markets are very nervous because they can see that there is a fatal flaw in the system and no clear way out,” said Theodora Zemek, head of global fixed income at AXA Investment Managers.

“We are in a very major crisis that has even broader implications than the credit crisis two years ago. The politicians have not yet twigged to this.”

Ms Zemek said the rescue had bought a “maximum” of 18 months respite before deeper structural damage hits home, with a “probable” default by Greece setting off a chain reaction across Southern Europe.

“It would be the end of the euro as we know it. The long-term implications are at best a split in the eurozone, at worst the destruction of the euro. It is not going to end happily however you slice it,” she said.

The warning came as Spain’s authorities were forced to shoot down German media reports that Madrid was preparing to tap the rescue facility after ructions in the inter-bank market.

Carlos Ocampa, Spain’s treasury secretary, said smaller Spanish banks are struggling to roll over debts but denied that the country is seeking outside help. “The rumour is false,” he said.

Spanish banks increased reliance on funds from the European Central Bank to a record €86bn in May.

Greece’s woes increased further as Moody’s downgraded Greek debt to junk status, saying the “macroeconomic and implementation risks associated with the programme are substantial”. The move is largely symbolic at this point since the European Central Bank has suspended its rating requirements for use of Greek debt as collateral for loans.

Greece is almost entirely shut out of the capital markets. Private investors are believed to have offloaded €25bn of Greek debt on to the ECB as it steps in to shore up the market, shifting the credit risk on to tax payers.

Axa said there was “no chance” that the EU’s €750bn “shock and awe” shield will succeed since it treats Club Med’s debt trap as a short-term liquidity crisis.

In the case of Greece the joint IMF-EU policy will increase Greek public debt from 120pc to 150pc of GDP by 2014, arguably making matters worse.

A number of ex-IMF officials have said the policy is doomed to failure since there is no devaluation or debt relief to offset the ferocious fiscal squeeze, and may endanger the credibility of the Fund itself. The IMF had floated the idea of a debt restructuring but this was blocked by the Brussels.

The strategy assumes that voters in Greece and other Club Med democracies will endure years of pain for the sake of foreign creditors. “It’s a pipedream,” said Ms Zemek.

Contagion from a Greek default would be harder to control than fallout from the Lehman collapse. “This has huge implications for banks. These bonds didn’t just disappear; they went somewhere, allegedly into French money markets and insurance companies, or on to French balance sheets,” she said.

The Bank for International Settlements said French and German lenders have £650bn in exposure to Greece, Ireland, Portugal and Spain, mostly in mortgage and company debt rather than sovereign debt.

The distinction has become meaningless in Greece. The ECB has lent Greek banks €85bn, mostly in exchange for collateral in the form of Greek government bonds.

This has kept Greek lenders alive as they suffer a slow bank run, losing 7pc of their deposit base since last June as wealthy Greeks shift their funds abroad. The ECB support is equal to 20pc of their non-equity funding, according to Lombard Street Research.

Axa said the America’s currency union is successful because Washington has over-riding legal powers over the 50 states.

“It is a precondition for the system to work but it doesn’t exist in Europe and the bond markets are starting to figure this out. We are looking at a noble experiment on the brink of failure,” said Ms Zemek.

The German taxpayers don’t fancy the prospect of picking up the tab for Greece’s rescue package.

This provoked comment from Chancellor Merkel that mirrored those of her Finance Minister earlier in the week which in effect dismissed chances of a monetary rescue package from within the Community, instead directing the Greeks to the IMF.

The Greek prime Minister took up the challenge, complaining about the delay in any progress and apparently resolved to the fact that Eurozone cash was not on the table. He told the European Parliament that his country was running out of patience and that in fact Greece was already subject to a ‘full IMF austerity regime’ but without benefiting from any of the IMF related advantages i.e. reduced cost of funding.

He said that savings that they were achieving through the strict cost cutting measures, rather than going to reduce their budget deficit, were finding their way into the pockets of bond-holders through spiralling interest rate costs. As if to back up his argument, Greek 10-year bond yields yesterday spiked again, up by 17 basis points to 6.26% – this as opposed to the 3.15% yield currently seen in the German equivalent.

On the back of the wrangling, the Euro dropped by a couple of cents against the Dollar.

To Wise Money it looks as though the Euro still has further to go with the attempts to project unity amongst the Euro zone members dissipating by the day. Next week’s EU summit meeting is assuming evermore importance given that the immediate future for the Euro itself could depend upon what emerges.

The contents of this blog are for information purposes only. It is not intended as a recommendation to trade or a solicitation for funds. The Wise Money Blog cannot be held responsible for any loss or damages arising from any action taken following consideration of this information.

The contents of this blog are for information purposes only. It is not intended as a recommendation to trade or a solicitation for funds. The Wise Money Blog cannot be held responsible for any loss or damages arising from any action taken following consideration of this information.

The contents of this blog are for information purposes only. It is not intended as a recommendation to trade or a solicitation for funds. The Wise Money Blog cannot be held responsible for any loss or damages arising from any action taken following consideration of this information.