Mayhem on the markets

Stock markets plunged around the world yesterday, raising fears of another global financial crisis and a prolonged economic downturn.

American investors - spooked by fear of a second US recession and the spread of Europe's debt crisis to Italy and Spain - started panic selling, which rapidly spread to other markets.

Last night European shares hit 14-month lows, following heavy losses in Asia, as the leaders of France, Germany and Spain prepared to meet for crisis talks.

London's FTSE 100 index declined 3.5 per cent, Germany's DAX shed 3.8 per cent and France's CAC-40 lost 2.5 per cent.

Earlier, the Australian share market lost $50 billion and the US Dow Jones index plunged 4.3 per cent in its worst one-day drop since the 2008 financial crisis.

More than $1 billion was wiped off the New Zealand sharemarket, and the Kiwi dollar dived from Monday's high of US88.42c to a low of US82.75c.

"You can't say much other than it's been a bloodbath today," said IG Markets analyst Ben Potter.

Martin Allison from Craigs Investment Partners said the world market moves were still being driven by what was happening in the US.

"If you really want to have a theme around all of this, it is debt," he said.

"There's a huge worry in the world about how we are going to pay all this debt back.

"Equity markets have just put their hands up and said, 'we give up'."

Prime Minister John Key warned New Zealand was in for a rough ride on the stock market, exchange rate and commodity prices for exports such as dairy products.

"We are in a time where it's very choppy in the international market place," he said.

"I don't think we can rule out the New Zealand dollar being quite volatile over the next three or four months as the United States works its way through trying to find a solution to the debt crisis it's been facing."

French President Nicolas Sarkozy, German Chancellor Angela Merkel and Spanish Prime Minister Jose Luis Rodriguez Zapatero were to hold talks overnight in response to growing fears that Europe's debt crisis is spinning out of control and the US recovery is stalling.

Investors took fright after the European Central Bank did not include Italy and Spain in a fresh round of bond buying, despite the high interest rates offered by both countries.

The move was interpreted as a sign that the bank is worried Italy and Spain - the third and fourth-largest economies in the Euro currency zone - could soon need a financial bailout, like Greece, Ireland and Portugal.

Italian Economy Minister Giulio Tremonti said Asian investors had told him: "If your central bank doesn't buy your bonds, why should we buy them?"

Analysts said Europe's financial rescue fund, currently €440 billion, would have to be doubled or tripled to cover Italy and Spain.

In the US, realisation has sunk in that despite this week's last-minute agreement to raise the debt ceiling, many elements of the US$2.1 trillion debt reduction plan are short term and not locked in place.

Doubt has spread through markets that Congress will stick to implementing it in full after the elections in November next year.

This, combined with a bout of poor economic data, points to a heightened risk of another slump.

"The big catalyst was fear," said Matt Rubin, director of investment strategy at Neuberger Berman in New York.

World commodity prices dropped, sparking fears that New Zealand's food exports could beaffected.

BNZ economist Doug Steel said the falling prices suggested a shake out, rather than a collapse.

Global economic conditions could get tougher but New Zealand had domestic strengths in its favour, including the Rugby World Cup and the rebuilding of Christchurch.