Financial markets the world over are in turmoil. Not because of any shortage of liquidity but because of its profusion. And not because of high interest rates but because they are very low. A paradoxical situation, indeed.

But what has happened in the last several months is that the financial wizards ensconced comfortably in their luxurious offices in the UK, Europe and the US and developing what seems to be ever new ways to spread risks and a make a quick margin for themselves have been packaging home mortgage loans (America’s sub-prime mortgage market) and forwarding them onwards to risk takers; who in turn borrowing at bottomed off interest rates were investing in these packages and then perhaps sold them onwards to hedge funders and private equities who had already extended themselves by borrowing cheap to invest in buy outs for profits.

But once the mortgage loans in the US became dearer and the backlog of used houses on sale started piling up as house owners found payment instalments getting out of their financial reach, the whole structure built on low interest carrying loans came down with a crash forcing lenders to call in their advances. In response without warning the inter-bank lending rates started going up steeply. It went up to six per cent in the US against Federal Reserve’s target rate of 5.25 per cent , in the Euro region the rates shot up to 4.7 per cent as against the target of four per cent. This was a signal for banks to start rejecting investment loan applications.

Sensing what was happening the European Central Bank (ECB), the US Federal Reserve and the Japan’s central bank came running with their billions to reassure the banks which despite the rising interest rates had become too wary of advance seekers. The ECB poured in nearly $200 billion. And the Federal Reserve injected over $60 billion. This had a salutary impact on the lending rates, but not on the sentiment.

All this is not as simple as I had tried to make out but I also know that I would lose the readers if I tried to elaborate the matter any further. Suffice it to say that for some time the world’s financial whiz kids have been trying to create wealth out of nothing and naturally they had to fail. Many have also found out, at a heavy cost to them and their clients, that it is a zero sum game. If it is not productive investment then what goes around, comes around empty handed.

In fact the leading brokerage companies ( there are said to be only three) are said to have lent money for the purpose of investing in loan packages and then bought these very packages from these investors to sell them further on. Can you have a more hilarious or more correctly a more madcap situation than this?

What, however, has saved the situation from becoming a real bust is the over all economic health of the world which in the last three to four years has shown a remarkable ability to go from one robust cycle to the next without any serious set backs. In this, the emerging markets led by China and India are said to have made the major contribution.

One feels that a stricter monetary policy at the right time would have discouraged the risk takers and higher cost of bank borrowing would have kept them on a leash. But then unlike in the past when the US Federal Reserve, the European Central Bank and the central bank of Japan among themselves could have done the needful and perhaps they did try to do it as well, this time around the market did not respond as desired because China, India and even Saudi Arabia, who along with a couple of other emerging markets have been pumping out money and creating a completely new financial phenomenon in the world.

So, investment resources in any quantity and at reasonable cost would still be available if the margins are right and returns are assured. But then in order for the world financial markets to return to some kind of order and grow in a balanced manner, those who are trying to misuse the abundance of liquidity to make a quick buck by insisting that they can turn iron into platinum need to be reined in by some easy to implement regulations.

Besides, the spectre of inflation is looming large on the economic horizon of the rich world, especially in the US. High inflation would surely force Federal Reserve to push up the interest rates. And this would have an adverse impact on the US economy and slow it down further making the world economy all the more dependent the emerging markets which have not yet reached the stage where they could be trusted to carry on the burden with economic equanimity.

Meanwhile, in a surprise development the rate of inflation in the UK has tumbled to 1.9 per cent in July against the full year target of two per cent. This would allow the Bank of England to maintain the interest rate unchanged when its monetary experts meet in the first week of next month. The largest downward contribution came from food prices, followed by furniture and furnishing, transport (petrol), housing and energy bills. The only large scale upward effect on the CPI annual rate came from clothing and footwear. The Retail Price Index (RPI) fell to 3.8 per cent in July from 4.4 per cent in June and was influenced by similar factors to those that affected the CPI.

Commenting on the fall in the official measure of inflation, the Consumer Prices Index (CPI), the Confederation of British Industries’ (CBI) Director-General, Richard Lambert said: “This unexpectedly big dip to just below the Bank’s target rate is good news and means that, especially with the current uncertainty in financial markets, the (BoE’s) Monetary Policy Committee (MPC) should sit tight on interest rates for the time being.

“The big surprise is the slowdown in food price inflation. Given the impact of bad weather on harvests and continuing high oil prices, there will still be upwards pressure on inflation. Nevertheless, various core measures of inflation which strip out food and energy prices have also fallen, and the medicine of five interest rate rises in a year is feeding through.”