Home News and Publications Articles The Crash of 2008
The Crash of 2008 PDF E-mail
Written by Charles Serruya   
Friday, 21 November 2008 00:00
For a few weeks in October it looked as if the whole capitalist system was about to implode. Blue chip banks in the United Kingdom and other countries seemed ready to fall like dominoes. Stock market indices reached historic lows. The pillars of the global financial system were tottering and capital was being destroyed on an epic scale. Government intervention in the US, in the UK and in the rest of Europe has prevented calamitous collapse - at least for the time being. The global financial system remains in intensive care and a deep recession affecting the ‘real’ economy now seems inevitable.

So how did we come to such a pass? There are many theories and many scapegoats. Bankers and  investment managers, hedge funds and speculators have been reviled and have had to shoulder the blame for this ‘crisis of capitalism’. But the truth, I believe, goes higher up the food chain and the causes stretch back decades. Ultimately the culprits are the politicians, mainly in the United States, but also in Europe, who in the 1990’s initiated an era of economic growth fuelled by cheap money and facilitated by the reduction of trade barriers, but then allowed this credit expansion to run out of control rather than take the difficult political decisions required to rein it in. In the early stages, the policy of easy credit led to increased demand which was soon matched by increased production in countries around the world, particularly China. The relocation of manufacturing production to ‘third world’ countries kept the price of manufactured goods low in developed countries. Manufacturing jobs in developed countries were replaced by service jobs. Wage pressures were kept down by immigration. Headline inflation remained low because of the effect of cheap imports. The politicians appeared to have found the magic win-win formula which resulted in both developed and developing countries (or at least those developing countries which were plugged into the global network) getting richer all the time. The rise of China and India in the last decade is undoubtedly the result of this policy.

However, this beneficent ‘goldilocks’ state of affairs was unsustainable and problems slowly began to appear. Western consumers did not want to spend all their new wealth on Chinese clothes or Korean plasma TV’s.  Some wanted to save, but what was the point in saving when the easy credit policies of the government had reduced interest rates to historic lows? Everywhere there was pressure for investment products that generated greater returns. These products often entailed leverage and high levels of risk which were often not made clear to punters.  The boards of listed companies were under intense pressure to keep growing profits. Unless they kept promising and delivering ever higher returns, companies would find that their share price would fall rapidly making them vulnerable to hostile takeover bids.

 Central bankers deliberately ignored the build-up of asset price bubbles.  When each bubble burst the problem was resolved by reducing interest rates further and pumping even more money into the system. As the credit boom accelerated, the risks increased and the consequences of a downturn became ever more dire. Therefore downturns had to be prevented and the economic cycle bucked. The only way to do this was to provide yet more credit. This repeated use of ‘hair of the dog’ remedies eventually led not to a hangover, but to a massive heart attack. The international financial system is still sick and now the illness is spreading into the ‘real’ economy. Most analysts predict a deep and prolonged recession. Some countries will be worse hit than others, but it is hard to imagine that any part of the world will remain unscathed.

Effect on Gibraltar

As far as Gibraltar is concerned we have to remember that the United Kingdom and Spain, our two principal trading partners, are likely to fare worse than most. This will have negative consequences for us. The most immediate is the adverse movement in the Sterling/Euro exchange rate. Spain is part of Euroland and therefore tied in to the strong-Euro policy of the European Central Bank which is inappropriate for that country given the current state of its economy. Therefore it is likely to suffer a deeper and more prolonged downturn than most European countries. The UK, with its large financial services sector, has been badly hit and the UK government is trying to mitigate the effects of the credit crunch by reducing interest rates. For the first time since the Euro was launched interest rates on Sterling have been reduced below those on the Euro. British politicians (apart from George Osborne) have been playing down the risk of a sharp fall in Sterling. In any event the British currency has already dropped against other currencies, including the Euro. Currency movements are notoriously hard to predict, but the possibility of Sterling falling to parity with the Euro, or even below, does not seem far-fetched. A steep fall in Sterling will have an immediate inflationary impact in Gibraltar since so much of what we consume is imported from Spain.

The fall of Sterling also means that there will be fewer British tourists on the Costa del Sol or on cruise liners and the ones that do come will have less money to spend. This is already affecting Gibraltar retailers.

As the recession begins to affect Spain, and unemployment rises, Spaniards will also have less money to spend when they visit Gibraltar.

Our residential property market has begun to slow down. Though prices are generally not coming down, housing sales have slowed to a crawl. The rental market is also far from buoyant. A number of new developments have been put on hold.

The gaming industry is also going through a period of consolidation with several of the large operators already having announced significant job cuts. This will have important knock-on effects, with decreased demand for housing and office accommodation, air travel, restaurant services etc.

The financial services industry is still to feel the effects of the credit crunch, but as major UK and other financial institutions start cutting jobs, it is unlikely that their Gibraltar operations will remain unscathed.

So what can the Government do to help? We are not going to get a lot of ‘bang for our bucks’ from major capital investment since most of the work will be carried out by non-Gibraltar constructors using imported labour and materials. Borrowing to fund large infrastructure projects is therefore likely to help the Spanish economy far more than it will help ours. We should not embark on expensive show-piece projects unless there is clear evidence that these will generate substantial economic benefits in future.

Fiscal relaxation measures are likely to have a wider and more immediate impact on the local economy as the recession begins to bite. Early implementation of the 10% Corporation Tax regime would help attract new business to Gibraltar. In the meantime tax exempt companies should be allowed to retain this status until 2010. Enhanced tax breaks for individuals who purchase or rent homes in Gibraltar would also provide some support for the local housing market. Finally a review of import duties and reduction of same in targeted areas would help restore competitiveness to the wholesale and retail trade.
Last Updated on Tuesday, 19 January 2010 10:59
 
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