First, the good news: oil prices dropped significantly the past few days. In the next few days, consumers will feel this at the pumps. We can expect a substantial rollback from our friendly neighborhood retailer.
Now, the bad news: oil prices are declining because a lot of people think the global economy is moving towards another recession. Some even say we never really climbed out of the recessionary cycle that began with the 2008 financial meltdown.
Last Thursday, the New York stock exchange dropped 512 points. Over the past ten days of losses, US stocks lost 10.5 percent of their value. To compound things, discouraging statistics regarding joblessness and manufacturing output are due down the road.
From Latin America to Europe to Asia, the markets dropped with the same precipitous speed. Something snapped here. The analysts are trying to figure out what that might be.
The most proximate factor explaining the late-week market bloodbath was the European Central Bank’s (ECB) decision, taken earlier in the week, to go on a bond-buying spree. That is similar to the two successive “quantitative expansion” programs undertaken by the US government. The intention here is to shore up the bonds, infuse liquidity into the economy and spur growth.
The markets, however, interpreted the move differently. They saw this as a desperate measure, given the circumstances. Greece was in a fiscal sinkhole; Italy is on a dangerous course towards default and Spain is not far behind. Greece is a small economy. The economies of Spain and Italy are both too big to fail and too large to save.
In the previous weeks, the world’s attention was riveted on the games politicians play in Washington over the debt ceiling. That turned out to be an exercise in futility. While a default was averted at the last hour, the focus of the intense political struggle was entirely wrong.
America’s immediate problem was high unemployment and slow economic growth, each feeding on the other. It was not the budget deficit per se.
The US does not have a liquidity problem. There are enough people lining up to buy US treasury bills, which means they are basically lending to government. They do so on a mere 2.5 percent interest gain, making government borrowing still affordable.
Raising the debt ceiling was a non-issue, as it has been for eight decades or so, when the ceiling was routinely raised by the US Congress 70 times. The imposition of a debt ceiling itself was a redundancy. The US Congress, wielding power over the purse, could regulate public spending by its yearly consideration of the federal budget. If the legislators wanted to cut the public deficit, all they had to do was to cut the budget.
The Tea Party ideologues, however, wanted to flex their newfound muscle. Having won a significant number of seats in the US Congress, they pushed the debt ceiling to the top of the agenda, highlighting their anti-Big Government agenda.
By resisting additional revenue streams for the federal government, the Tea Party politicians reduced the capacity of government to deal with the sickly economy and rising unemployment. The real malaise, after all, is in the domestic economy and not (for the moment) in the fiscal sphere.
All the suspense over the possibility of a US default simply shattered market confidence. By politicizing fiscal management, they raised uncertainty over the ability of the US government to competently manage its financial affairs in the future.
Over in Europe, all the EU’s best efforts could not save Greece. Nor has the gospel of fiscal prudence upheld by the powerhouse economies of Germany and France appeared to have impressed the Italians. The financial problems afflicting several economies around the belly of the Eurozone appear like a flood the dike of ECB intervention might be unable to hold back. Greece is already a leak in that dike and the ECB might not have enough fingers to plug all leaks.
The unexpected market reading of the ECB’s decision to flush liquidity down the markets by buying up bonds also happened in Japan. When Tokyo’s monetary authorities decided this week to dump yen on the market to arrest the currency’s sharp appreciation, it was likewise interpreted as a desperate and ultimately futile move. The market responded with a sell-down.
I think the thing that snapped this week was confidence in the ability of governments to effectively govern the markets.
That confidence was already severely strained since the 2008 financial meltdown. There was, even then, a sense that the regulatory regimes governing a rapidly ballooning “Planet Finance” were inadequate. Now there is a sense that no regulatory regime will ever be able to adequately govern the world of finance, whose resources vastly outstripped those of the states.
In the past, the fear in the markets was often tamed by the thought that governments will always ride in, like the cavalry of yore, to save the markets from self-destructive behavior. Now, that consoling thought has lost its hold.
The massive sell-down we saw the past few days in all the world’s stock exchanges are symptoms of profound panic. People are basically reconverting their stocks and bonds to cash. That volume of cash will be stashed in the global banking system, taken away from otherwise more productive use. Soon stashing money in banks will be no more economically beneficial than stuffing cash in mattresses.
When a global slowdown occurs because of the sell-down we now see, the money stashed in banks will have no borrowers. They will be ballooning liabilities for the banks, creating immense strains in the system.
There should be a way out of this global predicament. The first step has to be to take the matter away from the hands of the politicians and entrusted to the real experts.