Stock markets are essentially where people bet on the future of the economy. This week investors have reached the conclusion, in large numbers, that the economic future is bleak and they are cashing in their chips.

Echoes of 2008. Is there any way out?
John Phelan
On 5 August 2011 13:50

“It's only when the tide goes out that you learn who’s been swimming naked”. So said Warren Buffet of recessions. The credit crunch revealed that much of the western world had been skinny dipping in debt for years. 

Initially they protected their modesty with stimulus but the limits of that have now been reached. The disastrous performance of stock markets around the world in recent days shows that the western economies are now splashing naked between the European Scylla and the American Charybdis.

The fresh chaos in Europe has been triggered by the failure of a second bailout of Greece. The bailout was as much about protecting Italy and Spain from a crippling rise in their borrowing costs as about buying time for Greece to get its house in order. But it didn’t. Yields on Italian and Spanish bonds have rocketed to 6.02% and 6.14% respectively, their highest since the euro was launched. 

Forget about too big to fail. These two dominos are too big to rescue.

The leaders of the eurozone are providing none of the certainty that markets thrive on. It is clear that, if the euro is to work, then the fiscal authority must match the monetary area. At present the monetary area, the eurozone, contains 17 different fiscal areas. 

There are two ways out of this; one, monetary authority can devolve downward, the break up of the euro or the exit of some members. Two, the fiscal authority could evolve upward with the creation of a body with the powers to tax and spend throughout the eurozone.

Which of these will happen is unclear. The politicians, wedded as they are to the idea of ‘ever closer union’, are pathetically reluctant to see the monetary devolution of anyone leaving the euro. On the other hand, voters in core EU countries are none too keen to assume the liability for the debts of the PIIGS which fiscal evolution would entail. 

The EU leaders preferred, third, option, a return to the pre crisis status quo, doesn’t exist. Yet as long as politicians insist this phantom third option is there and try to keep it alive with one more bailout sticking plaster after another, the more uncertainty there is in markets about which of the two actual options will eventually be chosen.

The United States has just emerged from the political theatre of the debt ceiling negotiations. But there is uncertainty because it’s not clear that the play is over.

Much was made of the dire consequences of not raising the debt ceiling but few pondered the consequences of raising it. The US, already $14 trillion dollars in debt, is going to add another $2.4 trillion to that.

The deal struck in Congress early this week needed some firm commitments to tackling vast Federal entitlement programs. The bill commits to $2.1 trillion of spending cuts over the next ten years but leaves the exact make up of $1.5 trillion of these to a bipartisan Congressional committee. Who knows what they will produce or when they will produce it?

Again we have a lack of the certainty in which markets thrive. President Obama acknowledged this, saying that it was “pretty likely that the uncertainty surrounding the raising of the debt ceiling for businesses and consumers has been unsettling”. 

It was when markets started to have doubts over the exact content of Italy’s budget package that Italian bond yields rose. Likewise, when markets looked at the Congressional budget deal they spooked.

But this isn’t the only factor behind the worst days on Wall Street since the depths of the credit crunch in 2008. As the budget non deal emerged from Congress, figures were released which showed the US economy in trouble. According to the Department of Commerce in June consumer spending fell for the first time in two years by 0.2%; incomes recorded the slowest rate of growth for nine months, just 0.1%; job creation fell to a nine month low, just 18,000; and unemployment hit a high for the year, 9.2%. 

When Barack Obama was elected president it was 7.3%.

In two and a half years President Obama has added more than $4 trillion to the Federal debt. It took his free spending predecessor eight years to add £4.9 trillion. For this vast expenditure he has bought an unemployment rate 2% higher than when he took office. His vast stimulus has failed miserably. The US is saddled with spiraling debt, a stalled economy, and leaders with no clear idea how to deal with it. 

Stock markets are essentially where people bet on the future of the economy. This week investors have reached the conclusion, in large numbers, that the economic future is bleak and they are cashing in their chips. This has nothing to do with the old Keynesian bogeyman of “animal spirits” and everything to do with the dire state of western economies and their vacillating leaders. 

The truly frightening thing is that the panic is rational. 

John Phelan blogs at The Boy Phelan and has written for Conservative Home and The Cobden Centre

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