Wednesday 10 August 2011
It's not the € or US debt. It's worse than that
| |
Wednesday 10 August 2011 |
The world must work together to stave off a new recession. The trouble is we've run out of weapons to fight it
What are the causes of the latest financial market meltdown and what does it mean? As usual in economics, there are many answers, but the two mentioned in most headlines - the crisis in the eurozone and America's loss of its triple-A credit status - are almost certainly wrong.
The decision by Standard & Poor's to reduce US credit to AA+ could become a nightmare for Barack Obama, the first president to suffer the humiliation of a credit downgrade in US history. Or voters could blame the Republican-controlled Congress. After the confrontation over government debt last week the proportion of voters supporting the Tea Party fell from a peak of almost 40 per cent late last year to 18 per cent - roughly the same as the 24 per cent of Republicans and 14 per cent of all voters who tell pollsters that Mr Obama "may be the Antichrist".
As a result, their pronouncements no longer have any real influence on markets. This was confirmed on Monday when the US Treasury enjoyed a cut in the interest that it has to pay on its borrowings immediately after the downgrade. This apparently perverse behaviour came as no surprise to sophisticated investors, who have long made money by doing the opposite of what the agencies suggest, for example, lending money at lower interest rates to Japan every time its status was downgraded by S&P.
It now appears that the US economy has not yet recovered the ground lost in the recession - and, worse still, that the recovery in the first half of this year fizzled out to an annualised rate of only 0.8 per cent. The upshot was that America had very little momentum going into the third and fourth quarters. Suddenly the self-sustaining growth expected by most US businesses and investors, by the Federal Reserve Board and by many analysts (including me) was cast into grave doubt.
The possibility, if not yet the likelihood, that the US might sink back into recession points to a second genuine cause for alarm. This is the sense that governments and central banks all over the world have run out of policies to revive growth. The US Government and the Fed appear to have no plausible options. Additional fiscal stimulus is ruled out by record deficits and political stalemate, while the Fed's efforts to stimulate the economy by printing money seem to have failed so far.
In theory, the US Government could try plenty of other policies - for example, infrastructure investment financed by asset sales or financing by the Fed to prevent foreclosed houses undermining property prices - but in practice such overt intervention seems impossible, given the political mood in Washington today.
The ECB failed to reverse the premature interest rate increases announced in March, which have already begun to damage growth. Britain remains stuck in economic limbo and China spent last week denouncing the irresponsible US and European policies, instead of proposing anything constructive itself.
And without any such international co-operation, the world will just have to hope that business and consumer confidence revive of their own accord. Sooner or later, the private sector will recover and generate some kind of economic revival. But it will be a long and painful wait if governments and central banks around the world cannot co-operate to avert another recession.The ECB has given the euro a reprieve, at least until the autumnThe US economy has been weaker than we thought for a decade.