Is Anybody Listening? Market Views of Comstock Partners, Inc. Thursday, April 7, 2005
This week, both the International Monetary Fund (IMF) and the World Bank, two conservative institutions not known as alarmists, issued warnings on investments and the global economy. The IMF stated that the huge and growing market for credit derivatives and other complex securities could suffer a serious and “disorderly” decline if conditions turned negative. They pointed to evidence that large banks may have gone too far in loosening credit standards in order to attract hedge funds as clients for both trading and lending. The IMF stated, “if market conditions turn negative, many investors in these products could rush to exit at the same time, causing market liquidity shortages that could amplify price movements. Furthermore, elements of risk management systems designed to deal with these complex products have not been through a live test, particularly to see if in time of need, counterparties stand ready to absorb the additional market and credit risks from those who would like to shed them.”
In a separate report, the World Bank warned that the global economic recovery has peaked and linked the severity of the pending slowdown to the willingness of foreigners to continue buying huge amounts of dollar-based assets. The bank pointed out that the global recovery has papered over structural imbalances that cannot be ignored indefinitely, and that the problem has received renewed attention with the decline of the dollar and hints from a number of Asian nations that they may diversify their monetary reserves into other currencies. Francois Bourguigon, the World Bank’s chief economist stated, “The global economy is at a turning point. Growth has peaked, and pressures to address global imbalances are growing, exposing important risks facing both developed and developing countries as the needed adjustments occur.” The bank urged a “coordinated response” to minimize the risk of a crisis. They called for the U.S. to reduce its budget deficit, the EU not to tighten its monetary policy, and the Asian nations to let their currencies appreciate against the dollar.
In sum, the two world organizations touched upon a number of issues that we have been concerned about in our various comments, mainly the fragility of the recovery, the underlying structural imbalances, the potential danger of derivatives unraveling, and the risks of a market freefall. Their warnings also fit well with previous concerns by Ottmar Issing, the EU central bank’s chief economist, that central banks (read the U.S.) were not paying enough attention to the potential pitfalls of asset inflation. After all of our prior comments, it is heartening to see a couple of conservative international institutions worrying publicly about the same issues that we have been so concerned about.
The problem is that too few in authority are worried. The U.S. budget deficit seems intractable, the EU is hinting at a subsequent tightening, and Asian nations are reluctant to allow their currencies to appreciate. In addition the U.S. trade deficit continues to rise while consumer debt is soaring and the savings rate seems headed toward zero. It is indeed unfortunate that the U.S. Federal Reserve as well as the vast majority of government and private economists seem oblivious to these serious problems that hold so much potential for serious economic and market damage.
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