US sub-prime gloom renews economic tsunami fears

Australian sharemarkets have tumbled this morning following a night of selling on Wall Street, triggered by renewed concerns about the impact of the sub-prime crisis.

At 1pm the S&P/ASX 200 is down 1.8% on yesterday’s close to 6703.0, a fall that at this stage exceeds the 1.91% drop to 13663.71 sustained by the Dow Jones Industrial Average in the US overnight.

The drop on US markets resulted from rating downgrades issued by analysts in relation to Citigroup, one of the US’s biggest banks, because of fears about its exposure the crumbling sub-prime mortgage market. This caused Citigroup shares to drop 8.1% and triggered a more general bout of selling on US markets.

Fears about the possible effect on the global economy of renewed financial instability also pushed the Australian dollar down from the highs of recent days to US91.69c by 1pm.

A sub-prime-driven slowdown in the global economy is a big part of the “economic tsunami” prediction recently issued by Treasurer Peter Costello. But another element of the tsunami factor – one that Costello would prefer not to talk about – was highlighted by departing Westpac chief executive David Morgan last night.

The risk Morgan talked about is inflation, and in particular that part fuelled by the spending spree currently being engaged with by both sides of politics. Morgan pointed to the fact that the more fiscal fuel spread by governments, the harder it is for the Reserve Bank of Australia to put out the inflation fire.

If we see three interest rates rises before the middle of next year, that would likely cause a slow down in the Australian economy, particularly the stuttering housing sector. If that happens to coincide with a global slowdown triggered by a resurgence in the sub-crisis and skyrocketing oil prices, we start to see the outline of just what an economic tsunami might look like.