August markets crash — new paradigm needed

In August this year, stock markets around the world crashed.

Two big reasons for this were quoted by the Guardian’s Larry Elliott on 5 August.

For Gavyn Davies writing in the FT, other factors were key.

For Larry Elliott, the first key factor was the state of the US economy. The subsequent downgrading of the credit rating of the US government from AAA to AA+ by Standard & Poor created a vicious cycle in which lower economic prospects for companies reduced the forecast ability of government to repay its debts, which reduced confidence in the US economy, lowering economic prospects… (It also cost Deven Sharma, president of S&P, his job.)

The second key factor was the Euro crisis: any country defaulting on its debts would place additional stress on the banks lending to that government, and reduce incomes for the companies and people who work for the cash-strapped country, thus affecting the economy.

For Gavyn Davies writing in the FT, the key factors affecting not the market crises but world GDP growth were the Japanese earthquake (changing a forecast 2% GDP growth into 2.4% contraction, with a knock-on subtraction of 0.5% from global GDP growth), and the loss of oil supply (2%-3%) because of the political instability in the Middle East.

At the same time, he cited the slump of real GDP growth in the US to 1%, as well as debt deleveraging, and widening credit spreads.

Both commentators are correct. These are all factors. But what is really going on?

What are the reasons underlying these factors? Why are the US economy and the Eurozone so weak? Why have credit spreads widened, why has US credit been downgraded?

Fundamentally these symptoms tell a story of two things: we are in an era of higher risk and lower expectations.

  • Wider credit spreads and lower credit ratings speak of higher uncertainty, a lower ability to predict the future.
  • Falling equity prices mean that future cash flows are expected to be lower, not just in one or two companies, but across the board. In all sectors, in all stock markets.

As the FT reported on 4 August, the worst hit stocks were those of the world’s big natural resource groups. These were hit hardest because when whole economies are forecast to slow/contract, the easiest prediction for the traders to make is that fewer raw materials will be needed.

Financial services also suffered because of fears of their exposure to the sovereign debt crisis in Europe, which is driven by the governments’ inability to raise taxes to pay for their over-borrowing, because of the weakness of their economies. Another circular argument.

But the problem with circular arguments is that there is no ’cause’. All factors are relevant, and all are part of the circle. But but no single factor can be identified as the primary cause. And therefore no one factor can be targeted as the solution.

The only solution is to find a new circle. A new paradigm.

Whatever the factors involved in the current situation and whatever the primary and secondary ’causes’, the basic expectation currently being expressed in the markets, the Euro crisis, GDP forecasts, S&P ratings, credit spreads, and a hundred other indicators, is that economic activity will be smaller in the future. And nobody quite knows how much smaller, so volatility has increased also.

In such a context, businesses need two things:

  • First, they need a resilient business model that can cope with the short term volatility
  • Second, they need a business model that can survive and prosper in a new paradigm for economic activity

These are the twin aims of Permabusiness.

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