Sebastian

We have come along way since then, I hope :-)

Yes, UBS appear to have incurred the biggest losses of any bank from the mortgage meltdown. Still, it is a testement to the strength of the Swiss Banks that they incur so much loss and yet carry on in a canter. A number of these banks are using the current market situation to essentially write down as much as possible, which is a far cry from this time last year when they refused to recognise there was even an issue.

Market expectations can change quite dramatically when there is uncertainty. The US dollar fell to a modern day low of just over 92 cents against the Canadian dollar in November, yet the Bank of Canada cut interest rates just weeks later in December. The market had no idea in December that rates would be cut by a total of 1.25% over the next few months.

Nobody says zero interest rates is a good thing. And in fact if you live in Japan you will find that the borrowing rates on offer are much, much higher than the overnight Central Bank rate. Japan has a savings driven consumer, yet this has done little to help the domestic economy over the past 18 years. Almost 70% of GDP in the US comes from the US consumer and with such a consumption driven economy, the US has historically and repeatedly proven itself to be able to rapidly recover from an economic recession/slowdown. Of course the country's debt is a massive issue, but the US is not alone in this respect. I still fancy the US' prospects of recovery over the UK, while I have very serious doubts about the euro area because of the diversification problems which have yet to surface as a very real issue.

It was tongue in cheek. You are right though about lack of concern in the US and the UK for the manufacturing base, and services base I might add. They are just too eager to hand over what took generations to build.

Against the US dollar and Sterling. The only currency that really matters to the CAD is the US dollar, because that is where almost 80% of Canadian exports go. Canada is the only G8 country where GDP actually contracted in Quarter 1, yet the Canadian dollar has held its own as investors still like the growth prospects of Canada, ahead of most other countries.

To grow an economy in distress you are not trying to attract funds that sit on deposit earning a high yield, rather you need to make borrowing affordable for foreign and domestic companies that want to start/move operations there or want to expand exisitng plants/services etc. All companies leverage their operations and look to borrow funds, ideally from a local bank. If rates are less attractive, labour is more expensive and the outlook for the economy is at best uncertain, then companies are far more likely to base their plants outside of the UK, like in the US, where overall costs and growth prospects over the next few years look like a much better proposition at present.

It is. But look at US and British Banks and their courting of Sovereign Wealth Funds to shore up their balance sheets. Mind you, in recent months, because of the massive write-downs, it is the Sovereign Wealth funds that look a little silly.

See above. Markets will go after currencies where the Central Bank is seen to be behind the curve. Sterling is currently benefiting from a temporary flow of funds as investors seek yield while there is continued turmoil in quity markets. This is not investment in the economy and these funds will flow out as quickly as they flowed in. If rates are not cut, companies may cease investment in the UK and that will cut-off another major flow of funds into sterling. Sterling looks certain to fall against the dollar over the next 6-12 months regardless of what the Bank of England does. But a succession of cuts back to say 4.25%, equal with the ECB, could in fact help the UK economy bounce much sooner than the euro zone economy and ultimately lead to a strengthening of the pound against the euro.

Higher interest rates in a contracting economy will mean an even lower pound, as medium to long-term investors will avoid the UK altogether. Canada cut interest rates by 1.25% between December and April and the Canadain dollar is trading at much the same exchange rate now as it was last December. Eventually markets will reward currencies where rates are cut to stimulate growth, because the growth stimulus is a long-run incentive to invest there. If your economy is losing growth and jobs, you want to encourage investment and not discourage it with high interest rates. Higher interest rates may not even protect a currency in the short run - look at Iceland.

Yes, but it contracted in June at the fastest rate seen since 2001 and that followed another contraction in May. The construction and manufacturing sectors also contracted sharply in June and all 3 sectors now reveal a recessionary state, i.e. an alarming acceleration in the slowdown. In fact the UK economy looks to be slowing at a far sharper rate than the US economy over the past 2 months and the UK could hit an official recession before the US. All UK economic data over the past 2 months has been appalling, but much of it has slipped under the radar, as everyone has been focused on the US. The only piece of good news out of the UK over the last 2 months were record retails sales numbers reported for May, but they have been dismissed by most analysts as either having been incorrect or as having been a complete once-off. Much of the concern and gloomy outlook for the UK economy has come from retailers.

Switzerland is my ultimate definition of a strong economy. 2.6% unemployment, steady growth year after year combined with low inflation and a current account surplus that puts the US and the UK economies to shame. They have a high standard of living generated from their own earnings, and not on debt issuance.

Once you move into economic contraction across all sectors, it is a level of rebalancing you essentially do not want. You want to raise interest rates when the economy is over-heating and cut them when it is at the point of under-performing the long-running growth average. When the economy is sick, a kick in the proverbials (rate hike) is not going to cure it.

One only needs to look at the US to see that a 3.25% cut in interest rates, in 8 months, has failed to turn the tide in the housing sector there. Mortgage holders are still paying the high rates they were paying last August, primarily because of the credit crunch and the retail banks refusal to pass lower borrowing rates onto their clients. Interest rate cuts are playing a secondary role to credit woes in determining mortgage rates. But one thing is for sure, there is absolutely no way the housing sector would have a chance if the Fed had not cut rates, even if a pick-up in the sector takes another 12 months. This underscores the argument that interest rate policy today will shape the market and the economy not today, but in a future 18 to 24 months. What this does highlight is that the Bank of England's reluctance to cut UK interest rates because of an unsustainable spike in commodity prices is very short-sighted and shows a Central Bank lacking in vision, i.e. reacting to inflation data today, as opposed to where the economy may be (or not be) in 2 years time. The UK economy is going down the tubes through nearly every sector at present - housing, services, manufacturing, financial services and Governor King really needs to take his finger out if the economy is not to fall over a cliff. The Bank of England has zero control over rising oil costs, which is an imported phenomenon and outside of commodity prices there is no inflation worth talking about in the UK. There is however a dramatically slowing economy, which should be the mainstay of the Bank of England's focus and policy right now. Sebastian

I work in the currency markets and it is quite extraordinary to see how the rather woeful economic data out of the UK and the euro area has been ignored by the markets over the past month. Evidence is growing that the slowdown in the UK and the euro area is accelerating at a faster pace than that in the US, but the focus has been exclusively on the deterioration in the US, particularly in the banking/mortgage sector. When the worm turns, it could be just as brutal on the other side, i.e. curtains for the euro and the pound and the wider band of European currencies, which have been getting away with murder. GDP in the euro area probably contracted in the second quarter and the euro area could be in a technical recession by the end of September, yet the ECB keep telling us the economic fundamentals in the euro area are 'sound'.

I think it was inevitible Paulson or the Fed was going to weigh in last night, especially after the collapse of the Californian Bank on Friday night. The US Administration is clearly worried by the negative sentiment that is eroding consumers wealth, on a near-daily basis. I have never witnessed such negative sentiment towards financials in my life and I think the bottom could still be a long way off. Economic activity in the US will remain sluggish for ther foreseeable future and the only way we will see a meaningful rally in US stocks is if we get clear evidence of dollar strengthening or significant retracements in commodity prices, though one will likely trigger the other. If commodity prices were to fall, investors in these markets will switch to equities or the dollar, while a strengthening in the dollar itself would attract greater foreign capital and restore some confidence in the US economy. It might take a large negative somewhere else, like the collapse of a European Bank, China's lifting of energy subsidies or political back-stabbing over ECB monetary policy, to force a US rebound. Don't rule out direct currency market intervention, which is now getting closer by the day I would think than at any time during this whole crisis. Sebastian

A weak pound does mean higher inflation in the current climate, where global inflation is commodity-driven. However even when the pound was trading near its highs, inflation was a problem in the UK. When you look at inflation, the problem stems from energy and food costs, which are going up even as the economy slows. The Bank of England cannot do anything about imported commodity costs, so essentially their hands are tied. Core inflation is only running at 1.5%, while the headline rate was at 3.3% in May. The fact the core rate has been largely contained means second round effects have not taken hold and are less likley to do so while the downturn accelerates. If one is to assume the commodity price explosion is a bubble, or is a train about to hit a wall, then taking the longer term view on inflation, the Bank of England should be confident inflation will moderate considerably through next year. Deflation could well become the theme next year, if Central Banks do not coordinate their efforts now to do something about the present situation. The Divergent policies of the Fed and the ECB are having a detrimental effect on financial markets and this has a lot to do with oil's record rally. A wrong policy decision by the Bank of England could be catastrophic and could plunge the economy into a very deep recession. A rate hike to curb imported inflation at a time when economic activity is contracting, at an alarming rate I might add, would be economic suicide and could trigger a vicious cycle where the currency comes under attack and the Bank is forced to raise rates again (and maybe again), simply to protect the pound. This would pit the UK in the economic wilderness for many years. Raising interest rates in a contracting economy, where inflation is an import, does not work. There are two central lines of thought at present with respect to monetary policy and inflation, that delivered by Ben Bernanke and that so hawkishly repeated by Jean Claude Trichet. One of these men is either brave or stupid, or perhaps both, while the other has placed an unerring finger on the global economic pulse. Over the next 12 months we will discover which of these men has made one of the most calamitous errors of judgement in economic history. While Bernanke currently looks to be wearing the red nose, time could conceivably prove he was the one that was correct and that the ECB's handbook on monetary policy was never applicable to the modern world. Sebastian

It is not correct to say gold is looked at in a risk adverse way these days. When risk aversion levels are at their peak, bonds and the yen, the swiss franc and the dollar are the preferred flights to safety. Nobody rushed to buy gold when the original credit crisis erupted in August. Investors obviously bought gold in September and October (say thanks to the dollar for that) but many couldn't wait to be rid of it yesterday when fear ran through the markets. Investors offload risky assets (generally those deemed to be inflated in value) during bouts of risk aversion and that is how gold is categorised right now (a risky asset). You must remember that gold prices are also boosted by money supply because traders can now (virtually) accumulate it at high leverage rates.

Risk aversion levels were on the rise and the dollar appreciated. If the dollar rises sharply, funds quickly switch from gold to dollars or from gold to bonds. People selling gold yesterday don't look further than a day ahead. It's much easier to open and close poistion these days and move funds around. I believe yesterday's decline was the sharpest one day fall in 13 months for gold.

US fundamentals are pointing to lower interest rates over the next 12 months and as a rule that is not a good outlook for gold. The reason why gold is seen to have a bright outlook over the next year is the assumption that US interest rates will decline while interest rates elsehwere will go up and the rate differentials will widen, thus leading the dollar further into decline. As gold is the mirror hedge for the dollar, it follows that gold should rise in price. But a global economic slowdown may well turn that argument on its head. Gold is not preferred to stocks and its steepest declines of late have come on the same days when stocks are firmly out of favour. The sad truth is that gold is also seen as a risky asset to hold and funds and investors alike that hold it obviously believe it is over-valued right now. Why else are they so willing to offload it?

But oil is probably 50% over-priced right now.

Gold is not a stock and a 3.4% pullback in a single day is significant. By the way that is now a 4.25% decline ($35.20). The important point about today (and we saw the same thing back in August) is that nobody is flocking to buy gold during a pronounced period of risk aversion. Gold is being sold off in the manner of a high risk asset today. It's recent bullish run was merely the flip side of the dollar's sharp decline during the same period. The dollar has taken a lead from the performance of stock markets of late and not vice versa. The dollar has become like the yen - if risk tolerance levels are up, sell it. It is only in the past couple of weeks that equity markets have begun to take any notice of the fact that rocketing oil prices have a lot to do with a sharply retreating dollar. Crazy oil prices means less consumption on other goods, which in turn accelerates a slowdown, which means a darker outlook and stocks begin to look less attractive. So while a weaker dollar may be seen by Paulson and Bush as the solution to stimulating demand for US products on one hand, if by proxy it means lower demand globally, then it's not necessarily a good thing for anyone. An equilibrium needs to be struck.

It will be interesting to see how gold performs through the rest of this week, in such a volatile market with risk aversion playing up. The problem with gold is that it is expensive to hold and unless you believe it is going to appreciate in value, you don't buy it. It is interesting to hear analysts discuss gold prices and predict it could rise to $2,000 simply because when prices are inflation-linked that is the true historic peak for gold. What one must remember though is that money has become very cheap since gold last hit its glorious heights and the lure of high interest bearing assets using high leverage rates has in essence made gold less attractive. Short-term greed tends to win the punters over longer run safety play.

Gold is down $28 an ounce today and that is a 3.4% drop in one day. That is a massive decline by any stretch of the imagination. It is worrying for holders of gold that the metal sold off so sharply on a day when risk aversion levels were at their peak. Gold is merely being used as a hedge for the US dollar and the only reason it has risen so much in the past two months is because the dollar has capitulated. I would be more worried were I holding commodity stocks by the recent trend downwards in copper prices. Copper prices may well be reflecting a true slowdown in global demand and the fact a wider economic slowdown is going to see a more prolonged period of decline in the price of base metals. Rio Tinto's purchase of Alcan might prove to be the worst-timed and most over-priced takeover in modern history, although if Rio can persuade BHP to force through an equally inflated takeover bid of Rio, then at least the shareholders of Rio Tinto won't be left holding the can.

Even if the rate jumps to 2.3%, a rate cut will still be on the cards in the not too distant future. Why? The downside risks to growth will be seen as outweighing the upside risks to inflation. There is sufficient evidence of an economic slowdown in the UK and one which is accelerating. The Short-term litmus test is this week's Retail Sales numbers. The adverse impact of the credit crisis on the UK banking sector should not be underestimated. Global economy is slowing and global inflationary pressures should follow suit. UK house prices are falling and to avoid a negative equity disaster hitting UK house owners, lower interest rates are required. Higher oil prices is a bigger threat to consumption and growth than to inflation. The Fed has set a precedent for other Central Banks. From December onwards, the UK's annual inflation rate should prove more favourable, because the year on year comparison will be made with record high inflation levels from the prior year. The markets expect a cut.