The real share sell-off has begun, now brace for the fallout: Gottliebsen

In the last hour or so of trading in the US, the margin borrowers had been sold out at the market bottom (as always happens) and there was a huge rush of buying.

Let’s not mince words about the severe implications of the chaos on Wall Street overnight.

In the last hour or so of trading in the US, the margin borrowers had been sold out at the market bottom (as always happens) and there was a huge rush of buying. Sometimes at the end of a session the Wall Street market manipulators adjust the prices to help their balance sheets. Other times it represents a basic turn. We will have a better idea when we see what happens in the Australian and Asian markets. But either way, the magnitude of the initial fall knocks the confidence out of the system.

This is the big sell-off we have been waiting for. It had to come. When it is over (and I can’t pick the bottom) we will have a better market. Here is some of the fallout:

– Lower interest rates sound like a good idea, but in this situation they will destroy the Australia dollar and make it harder for our banks to raise money.

– The world is in the midst of a fear-driven massive deleveraging exercise and the fall in share prices will spread to commercial and residential property. The fall in property in some areas will be as severe as the fall in shares.

– The fall on Wall Street, with the Dow Jones Industrial Average initially falling well below 10,000, is triggering a wave of chart selling because that was the support level. That’s why there was a desperate effort to get the market to close back above 10,000, to avoid even more selling – which failed in the last few minutes. The same issues will arise in Australia as we fall below 4500.

– The fall is being multiplied by the unfortunates (or silly people) who leveraged share investments. In the US the banks have been making margin calls on a regular basis all night. And people have to sell, and sell quickly. The same will apply when the Australian market opens and I am sure that the calls for margins will start around 6am. We have about $22 billion in margin share loans in Australia and their forced selling will propel the market down here as it has done in the US, where the situation is worse.

– As I have been saying regularly, Wall Street was never priced for a deep recession and a downturn that lasted two to three years. The fall on Wall Street begins that adjustment.

– The Australian economic downturn will be severe as people cut their spending in the light of their house price falls. The commodity price fall is negatively affecting mining shares, but later it will also hit government revenues. But the worst will be delayed by the inflated price of resource contracts which fall in 2009. Australians have to hope that the stimulation of the Chinese economy works. I will elaborate on these points later.

Many people are wondering why the US rescue package did not create the environment to avoid this crisis. Had the initial Paulson plan been passed quickly, I think it may have worked because it would have caused a quick injection of confidence into the global system. But by the time some of the world’s worst politicians had debated it at the Congress, the nakedness of the US banking system, as revealed by Paulson and Bernanke, had been on display for too long. Confidence evaporated.

In addition, the legislation has become so complex that it will be cumbersome to operate and will only be used by banks that desperately need it. Just as bad, it has been combined with crazy pork-barrelling schemes such as assistance to motor car racing. Worst of all, it did not address the major problem – the need for bank capital which is now very hard to obtain given the further fall in share prices. So the US banks are undercapitalised, given their losses, and so must restrict lending which reduces asset prices.

The European banking system is in turmoil because their banks have also lost big sums in the US. But in addition, the recession that started in Britain is spreading as asset prices fall and fear grips the banking system there. They too have capital problems.

And don’t forget our Business Spectator’s KGB Interrogation interview with Reserve Bank Assistant Governor Guy Debelle who explained that the interbank loan system is clogged with fear. The central banks are providing a bypass, but in these circumstances banks slash lending, which fosters panic.

Coming back to Australia, we find ourselves in a very vulnerable position. We need overseas borrowing to keep our banks lending, but overseas money is very hard to get and only available at high prices. The traditional central banking stance is to cut interest rates. As we can see by the low rates in Japan and the US, this does not help much because it is not the cost of money that is at issue but rather its availability. But that won’t stop Australia reducing rates because that’s what central banks are programmed to do in these circumstances and, given the local anticipation, they must do it.

Lower Australian interest rates combine with the lower commodity prices to put pressure on the Australian dollar and make it harder and more costly for our banks to borrow money. Overseas investors have taken an absolute bath in our market. If you loaned money to our banks unhedged, you have just lost more than 10% of you capital. To describe what world lenders to Australia are saying about our Reserve Bank is unprintable.

Overseas investors who have invested in Australian shares and property have received a double blow – lower currency and lower prices.

Given that our largest and wealthiest state NSW created its own severe downturn because of incompetence in all areas of government, the Australian economy starts from behind and is in clear danger of a recession. The country will experience a downturn as banks restrict capital and asset prices fall. In turn this will fuel unemployment and lower revenue from employment contracts as consumer spending is slashed.

Because this is happening around the world as part of a global recession, is almost impossible for us to escape. But remember that we have seen all this before and it passes after two or three years. Sometimes it is longer. What all of us fear is a global banking meltdown. I don’t think that will happen, but if it did we would have a depression. The fear of a banking meltdown is part of the panic selling.

This article first appeared in Business Spectator