Every financial crisis throws up its own crop of clichs, but this credit crunch has thrown up a humdinger one that makes me wince every time I hear it. Over the past few months, it's been impossible to open a newspaper, read a broker note or talk to a banker without being warned about "the next shoe to drop". I've not been able to discover the origins of this hackneyed phrase, but it's supposed to conjure up the image of disasters waiting to happen. Shoes that have dropped so far include subprime mortgages, leveraged loans, quant funds, inter-bank lending and US house prices.
The good news for whoever has been dropping these shoes is that the US Federal Reserve's 0.5 percentage point rate cut this month seems to have done the trick. Bankers and brokers are optimistic the worst of the technical crisis is over. The cheaper money sloshing through the system has eased the pressure on positions that were deep under water, reducing paper losses and allowing people to get out of stuck trades. The bad news is that one unwanted side-effect of the Fed rate cut has been to trigger the dropping of the biggest shoe of all: the dollar.
This dollar crumble looks like the start of a major secular shift. People have warned for years that the US current account deficit was unsustainable. Following the rate cut and with the US economy slowing, there may be more rate cuts to come these investors now seem to be turning their back on US Treasury bonds. But the big question for investors is what the dollar will fall against and how to profit from it. So far, the dollar has weakened against the pound and the euro. But this can only go so far. The strong euro is already provoking protest in France. If the euro rises further, the anger will spread to other export-dependent countries. Meanwhile, the rise in sterling looks irrational since the UK suffers from the same imbalances as the US. If anything, Britain is even more vulnerable.
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At this point, doom-mongers start talking about the merits of gold. But investors can do better than this. There are now plenty of countries in the world that offer all the characteristics you would look for in a safe haven: large trade surpluses, small government debts, large export sectors, high savings rates. These are the "emerging market" economies of Asia, the Middle East and Latin America. Yet many still think of these countries as high risk. But that is to ignore the remarkable transformation these economies have achieved since 1998. True, some of these markets now look expensive, with "spreads" over US Treasury bonds having narrowed sharply over the past few years. But that is to look at the world the wrong way round: the narrow spreads reflect the exchange rate risks for foreign buyers of US bonds. What's more, debt analysts now reckon that many emerging market countries, such as Brazil and Russia, now offer lower default risk than some western countries notably Italy.
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For years, most emerging markets have pegged their currencies to the dollar. This has served them well, enabling them to build up big export sectors and large surpluses. But maintaining exchange rates is becoming difficult. Many have domestic inflation worries and cannot afford to match US rate cuts. Saudi Arabia decided not to cut its rates this month, suggesting Middle Eastern countries are prepared to allow their currencies to appreciate. At some point, China will be forced to allow the renminbi to rise. Some analysts talk of 30% currency appreciations across Asia. The only question is whether this takes place gradually or whether it happens very quickly, triggering further shocks.
Either way, investors should increase their exposure to emerging markets. Both bonds and equities will benefit from currency appreciation. Probably the best bet is to buy local-currency-denominated debt. There aren't many emerging market debt funds around but fund manager Ashmore runs offshore funds that are open to retail investors. Your IFA should be able to tell you how to access them. Do it before the next shoe drops.
Ruth Kelly, secretary of state for transport, has given London businesses an ultimatum to cough up cash within the next week or the government won't go ahead with Crossrail. This is no way to build a railway, but I'm not surprised Kelly has resorted to brinkmanship. If the government is even thinking of calling an election this year, it must agree to build Crossrail or forfeit any claim to be a responsible guardian of London's status as a global financial centre.
I've yet to meet a single business leader in London who doesn't think Crossrail is vital to the city's prosperity. This new rail line connecting Heathrow and Docklands is so important that Canary Wharf once even offered to build Crossrail itself. But the government rejected it out of hand. Now it is blackmailing private companies in an attempt to meet an artificial electoral timetable. Sensible funding suggestions from business, planning gain taxes, seem to have gone nowhere. Most outrageously, the government has even made threats not to build the line beyond Tower Hill. That is deeply cynical. Business should call Kelly's bluff and see if she has the guts to carry out her threat.
Simon Nixon is executive editor of Breakingviews
