MLC warns of new market crisis as key issues remain untackled

The financial services industry is heading for nothing more than a lacklustre recovery and is highly vulnerable to shocks, claims Susan Gosling, economist, capital markets research, at MLC Investments.

Despite renewed optimism and expectations for sustained market recovery in 2010, Gosling pointed to unresolved issues in the global financial markets — a concern for over five years — as key barriers to recovery. Major concerns raised included the fact banks have only recognised half their expected losses, US consumers are facing a multi-year reversal of prolonged overspending and Chinese growth is relying on massive expansion in fixed investment funded by state directed spending. These issues combined point to a weak recovery and could potentially lead to a new crisis, she said.

“Is it only a matter of time before there’s a new crisis? The jury is out on this. If the excesses are not cleansed from the system but instead continue to build, there will be a new even worse crisis. The warning signs will be growing optimism and soaring risk asset prices. Excess liquidity is the driver of this outcome, returns could remain stellar in this scenario for a time but it would end very badly indeed,” she said.

In addition, the massive transfer of private sector debt into government borrowing has put confidence in currencies at risk and could be a source of sudden and high inflation, she added. In this situation, inflation rates would rise above cash rates, resulting in savers being penalised and debtors bailed out, a highly unpleasant scenario with major risks for investors.

Gostling added that while the fiscal rectitude of the Australian public sector should provide some protection going forward, the private sector remained exposed. Indeed, Australia’s dependence on the rest of the world for capital and export demand as a growth driver makes it vulnerable, she stated.