We are in an ‘L’ of a mess on all fronts
Across America and Europe the markets have priced in a relapse back into recession. But there is something much worse that investors fear. It is a failure of leadership – in America and in Europe – to lift us out of a self- fulfilling collapse of confidence.
How have we gone, in a few months, from an expectation of modest but hopeful recovery to the precipice of a prolonged debt depression – one we thought we had avoided in the financial crisis of 2008-9?
There is a growing sense, not just of recession but of a much larger, epochal step change. In America as much as in Europe, the belief is gaining ground that this will be no short dip back into recession but a period of negative to low growth stretching for years ahead.
Too pessimistic a view? In America last week the yield on US government bonds was driven down to its lowest since 1950. Here in the UK, research by the Bank of England showed gilt yields have fallen to their lowest since 1899. Investors are now pricing in a financial crisis and slump greater than that of the Great Depression.
Little wonder that all eyes are now focused on the annual banking get-together next weekend at Jackson Hole, Wyoming. US Federal Reserve chairman Ben Bernanke and European Central Bank (ECB) president Jean-Claude Trichet will both attend. Hopes are now desperate that Bernanke will signal a further bout of quantitative easing (QE).
But there is still insufficient support for this in the Federal Open Markets Committee. As for the ECB, it is reluctant to take on more liabilities on its balance sheet while Germany’s Angela Merkel will not countenance the introduction of “eurobonds” without a Euro-wide iron grip on the budgets and fiscal policies of the member states.
Little wonder markets are running out of hope. The market plunges, says veteran UBS economic guru George Magnus, “reflect not only a rise in anxiety about the deteriorating health of the global economy, but the draining of confidence that political elites are up to the task of addressing it”.
Allied to this is a growing view that we did not dodge but only delayed the consequences of the banking crisis, and indeed may have made them worse. The transfer of vast debt obligations onto the balance sheets of governments and central banks in 2008-09 fed the illusion that a debt transferred was a debt paid off. What a delusion that was.
In the immediate aftermath the consensus was that economies and markets would rebound. Little therefore needed to change, either in the structure of these economies or in the dynamics of government spending and borrowing, barring some short-lived belt-tightening. This, too, has proved a mirage. Now add to this the loss of faith in the ability of conventional politics and government to handle the scale of the challenge we face.
Political divisions have sharpened in intensity. Last week saw an American presidential candidate Rick Perry denounce any further resort to quantitative easing by the chairman of the US Federal Reserve as “tantamount to treason”. With this sort of rhetoric, what hope is there?
Despite tough-sounding austerity talk, deficits and debt have continued to grow. America narrowly avoided formal debt default by last minute agreement to raise its $14.3 billion (£8.7bn) debt ceiling – but still lost its Triple A credit rating. Here in Europe, Ireland, Portugal and Greece have already required bail-outs. Spain and Italy saw massive rises in government bond yields, prompting emergency purchases by the ECB. France then became the target of attack. Whatever “solution” is adopted, the crisis just gets bigger. Amid all this, serious collective action to halt a slide into recession has been notable by its absence.
Governments cannot resort to higher spending because the politics of vote-buying has taken borrowing to the limit of creditor tolerance. Resort to higher taxation may provide a temporary boost to revenues. But this hits consumer pockets, depresses spending and denies governments the very growth needed to bring down those sky-high debt ratios.
Remarks last week by Paul Polman, chief executive of the consumer products giant Unilever, sent more shivers down the spine. Europe and America, he warned, were entering a period of “low growth” so the group is now planning to have 75 per cent of its revenues in emerging markets by the end of the decade.
To this has now been added the spectre of global slowdown, knocking hopes of an export-driven recovery. Conventional “V” or “U” shaped recovery is now being replaced by arguably the most nightmarish shape of all in economics – a prolonged “L” .
It is this prospect that explains why the market falls experienced last week were beyond any reasonable response to disappointing US data on manufacturing and employment.
Prospects are no better in continental Europe where Germany, the continent’s motor economy, reported a sharp slowdown to growth of just 0.1 per cent in the second quarter. The French economy is at a standstill. And there was nothing in yet another of those photo-op summits between German chancellor Angela Merkel and French president Nicolas Sarkozy last week that brought comfort – either in immediate and urgent reform of EU financial institutions or in an economic strategy. On the contrary. The summit came out with plans for a tax on financial transactions. There were few more effective ways of worsening the mood in markets.
So the fear now is of a prolonged recession, stretching for years ahead. If there is no prospect of a cyclical upturn, then market prices will adjust accordingly. What is now desperately needed is targeted QE, a shift away from crippling, money-no-object welfare budgets, a sharp reduction in business taxes – especially on employment – and political leadership to see all this through. The flight of confidence will not stop until these are evident.