LONDON (ResourceInvestor.com) -- Last week saw extraordinary volatility across financial markets. From equities to commodities, prices were up and down like never before. Gold both rose and fell by the largest dollar amount ever. Equities were sold down savagely early in the week before having a monumental rally on Friday as the U.S. government moved to take its policy of bailing out the stricken U.S. financial system onto a whole .
Will this be enough to end the chaos? That is unlikely, although it will act as a palliative. We are still in the midst of an immense process of deleveraging. Debt and credit, two sides of the same coin, will always be an indispensable aid to economic growth. But lax control of debt and credit has led us here, to the credit crunch. There will now be a retrenchment, and somewhat more cautious lending will prevail, at least for a time.
That has implications for financial markets, and for the wider economy. Much speculative activity in financial markets has been predicated on the availability of cheap and easy credit, which has facilitated margin trading on a grand scale by the myriad hedge funds that have sprung up in the last decade or so. Now, the degree of this margin based speculation must be reduced, and for better or worse, the way in which financial markets operate will change.
As for the wider economy, housing equity withdrawal (borrowing extra money on a home as its value purportedly increased), easier availability of high limit credit cards, whopping car loans to keep the latest metal rolling out of the showroom; all these things have sustained the consumer led boom that the Western economies have enjoyed in recent years. The moderation of these factors combined with the crash in the value of many financial assets (as well as homes) means that the consumer is on the back foot, and will be for a while. That will have an effect on the real economy.
When it comes to blame, there is plenty to go around. Plenty goes to certain Western central banks, for keeping interest rates too low too long after the dotcom crash. Some must go to financial regulators who simply had too little idea what the financial sector was actually up to. And some must go to the financial sector itself, for, in some cases, seemingly having little idea what its own people were up to.
Of course, the issue of interest rates was complicated by the significant anti-inflation effect of the seemingly almost unlimited cheaper manufactured goods that were available from China until recently. The prices of Chinese manufactures are now rising, so that particular free ride is over, but while it lasted, it encouraged Western central banks to maintain low interest rates and yet still enjoy low inflation. That in turn contributed to the creation of over-easy credit conditions.
Are we now done with the bailouts? Maybe, but there has even been talk that next up for U.S. government help will be Ford, Chrysler and GM; titans of American industry, but behind their Japanese and Korean competitors in providing the cars that Americans now want, saddled with a labour force that is too expensive, and as a result, teetering on the edge of bankruptcy. After Detroit's bailout, what would come next? Help for the airlines?
An automotive assistance package would probably lend more short term support to equities, just as the proposed financial system bailout has done. But in the long term, everyone has to adjust to the real economic ramifications of what is transpiring here. To some extent, commodities will be cushioned by Chinese demand, but that will help some commodities more than others.
