Credit

It is quite possible that we shall look back on the current credit crunch as the moment when the USA’s dominance in the world’s capital markets finally ended.

The biggest financial institutions in the world have spent the last few years busily taking on a great deal more risk than they understood in the pursuit of profits.  There is nothing wrong with a company making profits, that is why they exist, but many years of profits are being wiped out in one fell swoop.  It is safe to say that most shareholders would have foregone some of the profits of the past in order to preserve more of their capital value, had they but known.  Only, they could not have known because the finest minds available to the likes of Citi Group and Merrill Lynch at incredible cost did not know that their money-making schemes were so fundamentally flawed.

Of course, had these banks adopted a more cautious approach, their executives would have been pilloried and then sacked or the bank would have fallen prey to a takeover, such are the demands of shareholders.  We sow what we reap.

Now, these great institutions, and others, have had to go cap in hand to China and the Middle East for capital.  When the dust has settled, much of the intellectual capital within these firms will partly belong to their fiercest rivals, sold on the cheap.  Oh, how the mighty have fallen.

From here in Perth, capital of Western Australia, where I am visiting, the residential property boom looks somewhat different from the one we have experienced over the last ten years in most of the UK.  In the UK, we have become accustomed to explaining away the furious rise in the prices of homes in terms of supply and demand, i.e., there is insufficient supply to satisfy the demand, which is rising.  There is plenty of land, it is just that we will not let anyone build on the bits of it which are sited where people want to live.  We have surrounded our cities with greenbelt, and very nice it is too, but it does nothing to alleviate the lack of supply.  That lack of supply when coupled with a seemingly limitless supply of easy credit, secured against ever rising prices, has fuelled a tremendous boom.  Now that one of those elements may have been removed as the credit crunch takes hold, it may be that the market will grind to a halt.  The fact that supply is inflexible makes the residential property market inefficient, amplifying the boom and bust cycle.

In WA, some things are similar; the economy is booming creating a surge in demand and mortgages are relatively easy to obtain.  The residential property market in WA, and probably most of Australia, is dominated by new homes.  Not for Aussies the problems and expense of living in a home built for the needs of a different century.  Also, WA is hardly short of land; an area the size of Western Europe accommodates just two million people, mainly around Perth, which is growing at a frightening pace.  Of course, some suburbs trade at a premium as the rich prefer to congregate together but bulldozers carve out new land for building every year.  Want a home?  There is a plot ready and waiting for you to build upon.  This ever increasing urban sprawl brings with it other problems but short of land they are not.  Those hoping for a home in WA may have to wait up to two years for a builder to get around to them, though.

So why have house prices in WA and the rest of Australia been booming much like the UK (and the US, amongst others)?  I put it down to confidence in the economy and easy credit.  It does not really matter what you pay for your home so long as you believe that someone will buy it off you for more (the greater fool syndrome) and the borrowing is cheap and expected to remain so.  No one cares that they are paying twice as much for their home as they would have done ten years ago so long as it doubles in value over the next ten years.  Thus do asset prices lose any connection with the fundamentals.  What’s more, the more they go up, the happier we feel.  Warren Buffett has spoken rather disparagingly of those buyers who wish up the price of investments and it does seem a little irrational to draw comfort from the fact that you will have to pay a great deal more for your next purchase.

Whilst we were in the throes of the boom, here, as in the UK, those who should know better explain things away as being different this time.  If, as seems increasingly likely, this boom derails next year, the same commentators and economists will be telling us how it was all so blindingly obvious that it was going to end in tears.  We wait with bated breath.

It really is the time for a few well worn clichés, the world's stock markets are having a real roller coaster ride, at the moment.  It is by no means unusual but they seem to be taking their cue from the US and the sentiment over there is all over the place.  No one is quite sure how big a problem the sub-prime crisis is going to be but it starts at huge and goes up to cataclysmic.

The big worry, assuming that the financial system does not implode, is whether the US will slide into recession.  The government, in the form of the Federal Reserve Bank, is pumping vast quantities of cash into the system in the hope that it can prevent it seizing up.  In this, they are being strongly supported by the European Central Bank.

The financial system has shown itself to be remarkably resilient in the past in the face of some very worrying events but, for many investors, this is probably a time to switch off the computer and not look at values for a year or so on the basis that investment portfolios are for life, not just for Christmas.

In these uncertain times, it is hardly surprising that some investors are turning their attention to Gold, the traditional refuge.  Gold has outperformed most major stock markets this year (up about 20%) as well as many other indices, although Sterling returns are hampered by the fact the Gold, like most commodities, is quoted in US Dollars.

For most investors, though, Gold presents a few practical problems.  Firstly, it is expensive and I doubt many bullion merchants would be happy to sell a small piece of an ingot.  Secondly, it is costly to store and insure; it is hardly much of a refuge for your money if it lying about the house.  Also, most investors would not know where to go to buy it.  On the plus side, allocated bullion represents no credit risk and it does represent a traditional preserver of real value, even if its track record in this is patchy.

Access to gold has recently become easier; a number of ETFs (Exchange Traded Funds) now exist, some of which give access to allocated gold bullion.  This means that investors can include Gold in their portfolios, whether it is a good idea or not is another matter.