Events of the past few weeks and days have been a start reminder that fear and the threat of risk contagion still stalk the world’s markets. Contagion (the rapid spreading of risk across financial and other markets as confidence plummets) carries with it the growing threat of an international financial crisis and a highly negative impact on global (especially western) economic recovery. Already there is talk of a possible ‘double dip’ for the US economy, which was already struggling before the recent ‘debt-ceiling’ debacle.
‘When the US sneezes, the rest of the world catches cold’ is an old adage that reflects the reality that the US economy is still the main economic engine of the global economy. The delay and political wrangling that preceded the debt deal (of August 2) were not good for the US or the rest of the world. At a time when financial markets were already flakey and psyched up (with slow US economic recovery, eurozone fears, the Middle East awakening, continued concerns about some banks, the apparent low level still of bank lending in some key sectors, etc.), the loss of the US top credit rating is a systemic blow. Both the US deal and the process that produced it have left no one happy.
The final deal was a real example of brinkmanship and very damaging to the US global position (and, therefore, much of the rest of the global economy). Using the threat of default on US debt as an internal political weapon was an unprecedented move. The deal involves $917 billion of spending cuts phased over the next decade in exchange for an increase (in two stages) of the US debt ceiling to $900 billion. Following this, further deficit reductions of $1.5 trillion have to be approved by Congress by December 23 to support a similar hike in the debt ceiling. If that latter agreement is not reached, then a further $1.2 trillion of spending cuts will be needed (they will come equally from defence and domestic spending).
These moves have staved off an immediate default, but the US’s reputation has been badly tarnished. At the same time, uncertainty and fear have been fueled. A remaining problem is that these policies are , at best, only a stop gap for handling the growing US debt mountain. In a leader in the August 6 , The Economist describes the US moves as ‘A lousy debt deal, rising fears of a recession, the danger of longer-term stagnation: America’s outlook is grim’.
Despite that apparent weakness of US politicians to tackle the underlying problems, The Economist argues that the Fed (the US central bank) can help with quantitative easing (ie printing more money), although fiscal moves would have been preferable. Quantitative easing alone, though, cannot save the US economy. Nevertheless, the US still has massive advantages over other rich economies. These include a young and entrepreneurial workforce, and the dollar is still the global reserve currency (at least for while yet). But a stronger and more positive political will and approach are still badly needed.
The US problems are themselves part of the continuing legacy of the ‘credit crunch’ that began in 2007 and which engulfed many banking and financial systems (but especially Western ones) across the globe. ‘Sovereign risk’, the risk that a country or group of countries might default on debt, now stalks the global markets . This fear is compounded by the continuing woes in the eurozone countries. Ireland’s problems remain, but Greece has now taken centre stage. In the past few weeks, there have been growing concerns about other eurozone countries, especially Spain and Italy. Cyprus (which is heavily exposed to Greece) has also attracted attention. Even France is beginning to attract attention.