How to catch a falling knife

An investor walks past an electronic board displaying market data

When investors have it in their heads that the price of shares is falling, and those falls are reinforced by demands for increased collateral from those who lent to finance the share purchases, it is difficult to make any kind of rational prediction about when and where more than a week of share-price falls will be halted.

In Asia, overnight, there were at least signs that the magnitude of the share price drops may be easing. But then there was the same kind of evidence in Europe and the US yesterday, and that turned out to be a false dawn.

None of this would matter if the stock markets were in a hermetically sealed box, labelled speculation, insulated from the real economy.

But the problem is that investors' anxiety is based on evidence of economic slowdown in many of the developed western economies. And that anxiety has the propensity to become self-fulfilling.

For example, shares in major US banks slumped. Citigroup fell 16%, Bank of America was 20% down. They faced a double squeeze: the loss of America's AAA has the potential to increase the funding costs of US banks; Bank of America was hurt by a $10.5bn lawsuit from AIG claiming damages related to mortgage losses in the last crash.

When the traded equity in banks falls in price to that extent, those who lend to banks tend to become nervous, to wonder whether they are correctly assessing the risks of lending to those banks. And when banks find their access to funding becomes harder and more expensive, that has a negative impact on their ability to supply credit to their personal and business customers, and to other banks.

This is how credit crunches start.

But perhaps more importantly, if all the talk is the risk of renewed recession in two of the world's biggest markets, the US and the eurozone, companies think twice about making that big investment to increase capacity or about hiring extra people.

Careless share-price falls cost jobs, to paraphrase that World War II poster phrase.

For a vertiginous sense of how far share prices could fall, the best place to gaze may be through the looking glass at gold. JP Morgan, which is not normally seen as sensationalist in its forecasts, is predicting that the gold price could rise from $1,700 to $2,500 by the end of the year.

If anxiety about the value of financial assets is such that gold - perceived as the last safe haven in the storm - is to soar by almost 50% in four months, heaven help us.

What could bring stability?

Well the underlying cause of this mess is the same as it was in the banking crash and Great Recession of 2007-9 - which is the recycling of the great surpluses of the exporting nations, China, Germany and Japan, into the unsustainable debts of the great consuming nations, the US, UK, and much of the eurozone.

Between 1998 and 2006, the high-savings economies - China, Japan, Germany - produced $1 trillion a year more than they consumed; and those of us in the rich deficit countries increased our indebtedness by $1tn a year to buy the stuff they produced.

Those so-called imbalances have not been corrected. Our lifestyles in the UK, US and much of the eurozone are still financed on cheap money, much of it in effect recycled from the savings of the countries that sell to us.

If you look at what's happened since 2008, banking debt has been reduced in the UK; but the corollary has been a rise in public-sector debt. The aggregate of debt bearing down on the UK economy remains at more-or-less record levels equivalent to around 400% of GDP.

As for a huge element of that indebtedness, household debt, that's fallen from around 180% of disposable income in 2008 to nearer 160%. But official forecasts by the Office for Budget Responsibility for any kind of meaningful economic recovery in the UK are predicated on that household indebtedness rising back to around 180% of disposable in the coming few years.

That either means the recovery won't actually materialise, because households won't want to borrow on that scale, or it means that the economy will remain vulnerable to an interest rate shock for the foreseeable future (if interest rates rise, the spending power of consumers would be devastated).

The solution to all of this is the same as it ever was. The high-savings economies, China, Japan, Germany, would have to spend and consume more - to boost global demand, create a market for the goods and services of the UK, US and so on, and help the indebted economies reduce their debts in a less painful way.

Growth generated by domestic spending in China, Japan and Germany would be optimal way out of the current crisis of financial and economic confidence, so long as the indebted countries took the opportunity to reduce their excessive debts.

That has been the obvious answer for some time. However, even with the rise of the G20 as the main global economic decision making body, with China, India, Brazil, Russia and South Africa all at the top table, the world appears to lack the governance architecture to achieve the conditions for this kind of enduring economic reform.

Robert Peston Article written by Robert Peston Robert Peston Economics editor

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  • rate this

    Comment number 416.

    #414 YA I NO

    1. Markets are not rational.
    2. If someone has spare cash they likely see gold as a better bet.

    Or plain enjoyment.

  • rate this

    Comment number 415.

    #412 AnotherEngineer

    I don't do "fantasise".
    Nor fantasy when it comes to money.

    Look up Zombie bank when you have the chance.
    Should be enlightening.

    Spot the Zombie bank on your High Street.

  • rate this

    Comment number 414.

    We read in many areas of the media Silver is not being produced or mined anything like the rate it is being used in manufacturing, Chine is crying out for it, why is it not rising at a rate in comparison to Gold ??? is everyone not tuned in to these markets or are they just not thinking Silver may go to $250 by mid 21012 can anyone explain this poor attitude to buy this precious metal ????

  • rate this

    Comment number 413.

    China and the others aren't saving more than they should, Europe and the US are saving less than they should, not a little because the latter have been so influenced by the inflationary economics of people like Keynes. What China should do is stop subsidizing exports, which it must do in order to counter the Fed's and ECB's cheap money.

  • rate this

    Comment number 412.

    Prudeboy 407-409

    work really gets in the way, but I am hoping to work somewhere there is no internet access so you will be left to fantasise in peace.

    There are a lot of points there. Let's stick to the repayment of the 'created' money.
    If the bank seizes the security then the loan will be repaid, at least in part. But what of the rest?

  • rate this

    Comment number 411.


    Steve Keen points out that when someone wants to borrow money the bank finds someone to borrow it from first.

    And, of course, the fact that it is written on a website does not make it true.

  • rate this

    Comment number 410.

    From a deposit of 100Euro banks can create a further 900 or so at 10% fractional reserve. Why is that hard for you to grasp?
    You are making the classic mistake of confusing the total owed by various banks to their customers with money. They cannot all spend it. The 100 units is just spread thinly across a lot of banks.

  • rate this

    Comment number 409.


    Meanwhile if McC&S reaches a high enough price then the banks will sell them and the management, past owners, will get a bonus.

    And don't forget the original owners have their wad. To do with as they like.
    We collectively have given them this money.
    The banks meanwhile are zombie banks.
    You can find them the world over.

  • rate this

    Comment number 408.


    No chance of repaying the banks' money.
    Then the banks go t... up.
    We now own the banks.

    McC&S still trading or else banks would be in an even worse state.
    Hence property prices overvalued.
    & we own them!
    McC&S are effectively a nationalised company competing against others not subsidised.
    Is that distorting the market?

  • rate this

    Comment number 407.

    "why it matters when money that banks have 'created out of thin air' is not repaid."

    Consider McCarthy&Stone retirement homes.
    Bought by their management from their owners with bank loans.
    The banks created money, subsequently given in payment to the owners.

    Market goes t... up.
    Management has their company confiscated by the banks.
    No chance of repaying the banks' money.

  • rate this

    Comment number 406.

    The notion that three economies that have managed their incomes and expenditures in a responsible fashion have to change their behavior so as to 'bail out' the three economies that have failed to live within their means for so many years does nothing but reveal the bankruptcy, hypocrisy, and desperation of the "spenders." Kudos to the Chinese, Japanese, and Germans for their sensible frugality.

  • rate this

    Comment number 405.

    404. Oblivion "Read the article - you are just ignoring plain facts. From a deposit of 100Euro banks can create a further 900 or so at 10% fractional reserve. Why is that hard for you to grasp?"

    Banks can create another 900 in IOUs admittedly.

    Here's a variation on the question: if a bank can create money 'out of thin air' then why would it ever need support from the gov't?

  • rate this

    Comment number 404.


    Read the article - you are just ignoring plain facts. From a deposit of 100Euro banks can create a further 900 or so at 10% fractional reserve. Why is that hard for you to grasp?

  • rate this

    Comment number 403.

    # 400. AnotherEngineer "exactly, but the myth is that there was no depositor."

    We're not in disagreement about this - I just answered a different question. But not deliberately :0)

  • rate this

    Comment number 402.


    In the best traditions of the blog here is a selective quote from a v long article

    If the bank that issued the line of credit was already at its own limit in terms of its reserve requirements, then it will borrow that amount, either from the Federal Reserve or from other sources.

    i.e. it does not create the money, but borrows it.

  • rate this

    Comment number 401.


    See? I just created 500 dollars

    No you didn't. If you owe me 500 dollars I must have paid it to you in real dollars!

  • rate this

    Comment number 400.

    396.John Bray

    Because otherwise the bank only has your IOU to hand back to its depositor if he wants to withdraw his funds.

    exactly, but the myth is that there was no depositor.

  • rate this

    Comment number 399.

    #395 AnotherEngineer

    Via a clearing house.

    For the sake of example:

    AnotherEngineer: I owe you 500 dollars. This receivable may be traded with whomever you choose.

    See? I just created 500 dollars.

  • rate this

    Comment number 398.

    #394 AnotherEngineer

    It does indeed quite clearly say that banks create money. Are you blind?

  • rate this

    Comment number 397.

    Isn't it ironic our fathers/ great grandfathers went to war to stop the Germans dominating Europe.Here we are today watching the Eurozone fall apart at the seems while the German's maintained diligent fiscal economics.So the German's will get the dominance they wanted all the time and the other Eurozone countries can do nothing about it and I think the UK will do OK out of it as a non Euro player


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