Crikey

Wall Street fell again on Friday night - with much of the fall occurring in the last half-hour of trading. Many people, including Henry, have been calling for a correction and urging caution by investors.

David Uren makes the good point that the global economy is still strong, and expected to remain strong. This is the base case for expecting the share boom to continue after the current correction has run its course, a proposition Uren endorses.

This is fair enough, and may even be right. There are two caveats. The first is the problem of international “imbalances”. These imbalances are manifest in the large current account deficit (CAD) in the US economy (and other western economies), offset by the large current account surplus (CAS) in China (and other surplus countries).

The world had been coping well with this situation but two specific recent events - themselves part of the unwinding of “imbalances” - have spooked investors. In the US the “sub-prime lending” housing crisis has seemed worse. In China, growth has accelerated and inflation is rising, despite rising interest rates and other attempts to slow the boom by the Chinese authorities.

The CAD/CAS imbalance investors can cope with, having had plenty of time to prepare their minds. The feeling the adjustment process may be getting out of control is a much less enticing prospect.

The second caveat concerns global interest rates. Central banks have been slowly but surely tightening the monetary screws with the aim of squeezing inflation - both asset and goods and services inflation - out of national and global economies.

Some have said that a share market correction would serve as an alternative to rate hikes in Australia, just as until last week they were saying a rising Aussie dollar was a substitute for rate hikes.

Over the weekend I even saw (wrapped around some fish and chips) Terry McCrann asserting rates are virtually sure to rise after the next meeting of the RBA.

We will know after that meeting, at 9.30am on the morning of 8 August. Henry’s April 2007 report is most directly relevant to the next meeting of the RBA board.

A sufficiently large equity market correction would represent an end (for the time being) of the most obvious manifestation of asset inflation in Australia, and this could indeed stay the RBA’s hand.

Read more at Henry Thornton.