Not-so-welcome Visitor

Sun Herald

Sunday March 23, 2008

David Potts. Nicole Pedersen-McKinnon is on leave.

There is no escape from a spreading US recession and its effects are already being seen here.

THE defining feature of the credit crisis has been that banks have stopped lending to one another because they don't know what is hidden where, but an even bigger problem is that it seems nobody else will lend to them either.

In this market, leverage - having a high proportion of borrowings relative to equity - is death.

And who is most leveraged of all? The banks, something that was all too easy to forget in a bull market high on cheap, accessible capital.

When the problem is expensive, inaccessible capital, the banks are suddenly pariahs.

I've mentioned before how the banks ran up our massive foreign debt. And with more space than usual I could add ... no, it's all right. I won't.

So let's not split hairs over whose fault it was - the banks for borrowing on the cheap, or home buyers for asking for the money, or even central banks for running a slack monetary policy.

The point is that these offshore borrowings have greased our economic boom, and if the rationing of global credit shuts them off we'll import the recession from the US.

And don't think China will let us off the hook, either. If the credit crisis has shown nothing else, it's that the systemic problems in the US banking sector are more than capable of spreading in unpredictable ways. It's almost as if they can just hop on a plane to somewhere.

Indeed, the credit crisis has morphed into a far more dangerous confidence crisis.

After all, one of the biggest casualties so far has been thousands of miles away from Wall Street - Northern Rock in Britain.

So it's no accident that our bank stocks have been marked down by the sharemarket much more than the US banks, some of which have been proved to be near insolvent. As the biggest winners from a glut of global capital, our banks lose the most from its rationing.

Just to maintain their loan books, they'll have to raise more capital as their short-term borrowings expire.

Locked out of borrowing internationally - or at least at a price they could pass on to their customers without sending them to the wall - the only option is equity raisings, which is why they're surreptitiously using their dividend reinvestment plans to raise capital by underwriting them.

Come to think of it, they'll also have to be nicer to their depositers.

But back to China.

Apart from its demand for iron ore and to a lesser extent oil, the commodity bubble is due to the collapse of the US dollar.

In fact, the Chinese authorities are lifting rates and tightening credit.

The credit/confidence crisis could well succeed in slowing down China's economy where the US recession fails - either by rationing capital, eventually resulting in a mountain of bad debt write-offs, or by pushing commodity prices up too far.

Sure, the commodity bubble has done a great job buffeting Australia from the financial turbulence.

But by overvaluing other currencies against the US dollar and dragging their economies into recession as well, and crippling bank lending, the credit crisis will eventually mug us too.

© 2008 Sun Herald

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