Black Swan event in Korea rattles global financial markets

Global stock markets are down to three-month lows today on news that North Korea has mobilized its military machine as tensions escalate with South Korea, a Black Swan event that nobody could have foreseen except perhaps the leader of North Korea.

At the same time more budget and public sector salary cuts in Europe are ushering in a new age of austerity that equity analysts increasingly realize is not going to be good news for profits going forward.

Contagion effect

For the US the plunging euro and pound cuts multinational profits in their biggest export market through currency translation, and clearly export volumes are also likely to drop amid spending cutbacks. The dollar-pegged Chinese currency means China is suffering the same fate.

The contagion effect is impacting commodity prices with oil down below $70 a barrel. This is rattling investors in the Gulf States where oil is a key economic driver.

So much for immediate fears about inflation. Bank lending is falling all round the world, and that is a deflationary force. Deleveraging threatens a decade of sub-par growth after an initial contraction or double dip recession. It was debt that fuelled the past decade of growth, and living with less debt will mean less growth.

Stock markets have actually been slow and reluctant to take this on board. They have been heartened by the impact of job cuts on the bottom line, thinking short-term as ever and not to the longer term of static or declining profits on smaller revenues. Indeed, markets will probably still have to see this before they finally get it.

Technical supports broken

Meantime, there is plenty to keep investors fearful and selling stocks both from a fundamental and technical level. Anybody who follows stock charts ought to be a seller by now. All the key technical supports have been broken in the US and around the globe.

The stage is being set for far more than a technical correction. This is going to be a major re-rating of valuations for an age of austerity in Europe. The US will probably end up taking a different route and instead of balancing its expenditure and income will monetize its debt and inflate it away.

That might sound an easier solution but all history shows that hyperinflation is an economic disaster. Many once strong economies have been reduced to ruin by this irresponsible approach by weak democratic regimes that are incapable of strong action to control deficits. It is tragic that the US is now choosing this option by default.