The past few weeks have seen some dramatic and apparently worrying developments in global financial markets. Last week’s meetings in Washington of The International Monetary Fund (IMF) and World Bank were full of ‘doom and gloom’.
There is certainly real cause for concern and a need for concerted, strong action in key areas like the eurozone. At the same time, there is a danger that the ‘experts’ may also help to talk down further already fragile markets. In this context, it may be as well to be reminded that the IMF and other bodies did not forecast the financial crisis that engulfed markets from early 2008 onwards. Being very negative now at least ensures that possible adverse downside developments are ‘covered’. More on this ‘good news’ at the end of this note!
Nevertheless, few would dispute the views of Christine Lagarde, the IMF’s new managing director, that the world economy is now in a ‘dangerous new phase’. Finance ministers meeting in Washington have warned that time is running out to find a solution to the eurozone crisis and stave off a global recession. As the crisis in the world economy has deepened in recent weeks, bank shares took a big hammering in the global stock market rout on September 22. The growing threat of another recession spooked investors and led to a flight towards safe havens as investors dumped shares.
The meetings in Washington have demanded a firm European approach to the problems of Greece in particular and other weak eurozone economies in general. The downgrading of Italy’s credit rating and the search for more capital to shore up French banks (and Moody’s downgraded the credit rating of two of France’s largest banks) all added to the worry list. Broad statements of concern and noble policy intentions from Europe are increasingly criticised as ‘pussy footing’ around the real problems. Specific and decisive policy actions are increasingly being called for to calm markets. The more that these are delayed, the greater are the constraints on the respective policy options to solve the problem..
In this context, policymakers in Europe initially put great store by the agreement that they struck earlier this year (July 21) to handle the eurozone crisis. This promised more money for Greece, together with enlarged resources and a wider remit for the European Financial Stability Facility (EFSF). However, theses moves have since hit troubled waters on several fronts. There has been some confusion, for example, about what the re-engineered EFSF should do and a growing realisation that the fund looks too small anyway for the job at hand.
Time and again, European finance ministers have appeared to flunk the hard decisions needed to calm markets about the apparent growing prospects of a Greek default and a wider eurozone crisis. US and other country commentators complain that these apparent failures in Europe are constraining their economy’s ability to recover (though the US is not really in a good position to take the moral high ground when it was the source of the last major ‘credit crunch’!). ‘America has lost patience with Europe’ screamed a recent headline in The UK Daily Mail (September 24). Superimposed on all of these problems is the apparent second quarter slowdown in the growth of many major economies around the world. In the eurozone, this certainly added to the problems as growing out of the crisis appeared to be a disappearing and irrelevant option in the near term.
So where are we at..? The immediate problem that has to be tackled firmly and decisively is the prospect of a Greek default and the wider eurozone crisis. The spreads on credit default swaps for European banks (a good measure of the cost of buying insurance against their default) are currently at record highs. The cost of banks lending to each other has also risen in recent weeks. These and other signals (like falling bank share prices and a search for greater bank capital) all add up to growing market concern with current policies in the eurozone.
The Economist (September 17) offered a rather gloomy analysis of the present eurozone crisis and the apparent policy options, especially if the eurozone were to break up. It concluded that the eurozone ‘offers scope for contagion, and confusion, on an epic scale. That is what makes its crisis so troubling – and so hard to treat’. Others argue that the costs of breaking up the eurozone may be so high that whatever policy actions are needed to save it have to be justified.
Another view is, perhaps, more pragmatic. It may now be too late to save Greece from defaulting and exiting from the euro. If that is a real prospect, then the eurozone ‘core’ countries that are left must make it clear that the rest of the eurozone will be fully supported and contagion contained. At the same time, any ‘moral hazard’ potential must be nipped in the bud – some countries seeing Greece ‘getting away’ with a default may be tempted to follow suit and free market discipline could be compromised. So no easy options! But something has to move and very soon.
Chris Giles in the Financial Times (September 24/25) came up with ‘five warning signs to watch’ in the present global economy. These are summarised below:
1. Third quarter economic growth. Reassuring bounce-back or descent into downturn?
2. Eurozone debt crisis. Will Athens stay afloat or deliver global shock?
3. Central banks. Will pro-growth steps pay off or prove futile?
4. Markets. Spiral into bear terrain, harbinger of recession?
5. US politics. Can a divided Congress drive consumer spending?
We are surely at a dangerous place in the global economy, but there is one big reassurance when trying to compare the present scenario to the last major financial crisis that began in 2007, the so-called ‘credit crunch’. This time policymakers have recognised and are addressing the present problems that carry the big downside risks. That has to be some good news.
But ‘watch this space’ since the next few weeks look to be critical ones in the continuing eurozone crisis.