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The global crisis that killed Goldilocks

The global crisis that killed Goldilocks

Mumbai: The credit crisis first made headlines exactly one year ago on 9 August, when French bank BNP Paribas SA halted withdrawals from three of its funds that had invested in US sub-prime mortgages.

A year later, the fallout of the crisis has spread far beyond the US and subprime mortgages, taking its toll on markets, currencies and economies around the world.

Which markets and asset classes have been the worst hit? Everybody expected the big banks that had gorged on the dodgy mortgages and their derivatives to be punished and the US economy to slowdown as its housing boom turned into a bust. But while there’s no doubt the US has had its share of the pain, the surprise has been that even emerging markets have not been spared.

Indeed, for a short while after the crisis erupted, the consensus was that countries such as India and China could “decouple" from the West and chart their own growth trajectory. That was the reason for a brief spurt in the flow of foreign funds to our shores, before decoupling was proved to be a myth. As risk appetite receded, foreign investors sold heavily and emerging markets fell.

Even so, the Indian market has not done too badly. The table shows that in the year to 7 August, while the Morgan Stanley Capital International World Index is down 16.22% and the MSCI Emerging Markets index is lower by 8.73%, MSCI India is actually up 0.28%. It’s one of the very few markets that don’t show a negative return.


Apart from the markets, the big surprise has been the sudden acceleration of inflation, a rise that has hit emerging markets, with oil importers such as India being hurt the most. While there are many theories that purport to explain inflation, one reason for the surge in crude and commodity prices has been the falling US dollar. Immediately after the credit crunch, the US Federal Reserve slashed its policy rates, leading to a sharp fall in the value of the dollar and the US dollar index fell to all-time lows. The upshot was that international commodity prices, which are denominated in dollars, soared. And, since emerging markets are more dependent on commodities, prices rose sharply. The central banks of developing countries then had no alternative but to raise interest rates, in the hope that slower growth will reduce demand and cool prices.

The rise in commodity prices led to a worsening of the outlook for countries such as India and the rupee depreciated against the dollar. In commodity-exporting countries such as Brazil, however, the currency appreciated and the stock market soared. Money fled stocks to find a new home in commodities.

A year down the line, after billions of dollars in losses by the big banks, after global growth has slowed substantially and after most markets are deep in bear territory, there is no certainty that the crisis is over. The big banks continue to discover new losses and will probably continue to do so as long as US housing prices continue to plummet. Concerted and swift action by the Federal Reserve and other central banks has managed to stave off a systemic crisis, but the spreads on credit default swaps are still much wider than where they were at the beginning of the year. And the big concern is that growth will slow even further in the US and Europe, dragging Asia down as well.

That fear has recently led to a fall in commodity prices, as slowing global growth leads to demand destruction. That has supported stocks and eased inflationary pressures.

It’s worth remembering, however, that it’s a far cry from the global Goldilocks (not-too-hot, not-too cold, just right) economy of 2003-07, when a combination of high growth and low inflation supported asset prices.

One year after the credit crisis first struck, it has morphed into a severe global slowdown.

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