James Saft, Reuters Columnist
The two current arguments for enthusiasm about asset and risk markets seem to be these: that policy forbearance and the European Central Bank can keep the eurozone intact until someone thinks of something, and; that coordinated central bank and fiscal policy will rescue the global economy anyway.
Both are untrue but, like most untruths, both contain interesting elements of truth.
The latest focus of hope is a planned Tuesday emergency telephone meeting of the finance chiefs of the Group of Seven nations to discuss potential salves to the eurozone crisis. The meeting, not the first and certainly not the last of its kind, is being held as the idea of a Greek exit from the euro becomes almost mainstream. More troublingly, investors have suddenly realised what has long been clear: that Spain’s banks and its treasury have been propping each other up like two drunks at a bar.
“There’s a heightened sense of alarm over developments in Europe, particularly in Spain,” an anonymous G7 source told Reuters. “There is concern on whether there will be a bank run in Spain that could have repercussions beyond the euro zone.”
Well, yeah, I guess it would, but a telephone call ought to sort that bank run repercussion risk right out.
This sort of babble doesn’t make me feel much better but apparently it does serve to inspire some investors to believe that policy-makers can limit their downside. If not, we’d have lost far more than the 10% or more equities globally have fallen, and never would have scaled this spring’s peaks in the first place.
Part of this reasoning is correct. Germany and the ECB have both the firepower and reasonable incentive to keep the ailing south respirating. Despite all the angry words there isn’t a hard and fast trigger which will force dissolution. Bank runs can be stopped, expensively, by central banks. Despite the fact that it may be against the rules and an offence against the German idea of justice, a steady flow of cash southward is likely in coming months.
Rescue does not revive risk
That does not mean that risky assets are attractive here. Europe’s solvent nations and the ECB may well keep things ticking over but while they do, the fundamental condition of the euro zone and global economy will continue to deteriorate.
Attempts to cut the knot between banks and their sovereign backers only underline the fact that one state must be replaced with another, in this case Spain and Greece have to be fully subsumed into a eurozone fiscal union, a process which will be long, difficult and no sure thing. Bank lending will be impaired, investment delayed and jobs lost. This implies that things will be considerably worse economically at the point at which some solution is reached. In other words, your risk isn’t just that something will force the euro zone to dissolve, but that world growth will melt while we wait.
This is not simply a eurozone issue; conditions are weakening most everywhere, from the US to India to China. The jobs figures in the US last week were poor, US factories show signs of slowing and Chinese manufacturing is sliding rapidly towards contraction.
The inevitable riposte to this is that authorities will respond with liquidity, cash and stimulus. Governments and central banks are indeed eager to avoid a negative feedback loop, and we can expect more quantitative easing or extraordinary measures in coming months from the Federal Reserve, Bank of Japan, Bank of England and assorted others.
It is unclear, however, why four years into a global debt crisis this should make us eager to take on risk, to invest in capacity and to consume. We have had upwards of four years in which monetary policy has been fixated on the idea of tempting cash into risk, and yet here we find ourselves. Similarly, though the experiment with austerity looks to have failed, we have had a decent experiment with stimulus which also has returned mixed results.
The global economy has two fundamental problems: the wrong things got built and invested in and too much money was borrowed to finance it all. The bad investments of yesteryear are not just sunk costs but an ongoing problem. Policy may not be able to wave a wand over a brick-layer and make him an electrical engineer, but it can clearly tempt money from the pockets of that engineer into bubbles like Facebook.
It’s time to really start attacking the debt problem, not by skimping and repaying but by writing it off and starting all over again, no matter whose nose is bloodied in the process.
(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com)