Today might see another rout on the markets or it might not, depending on what if anything central bankers did or said at the weekend. It would not take much either way.
EU leaders are under pressure to agree immediate steps to rescue Greece (and other euro-zone members) or risk a financial collapse. As a senior figure at Lloyds put it to The Guardian: “If we come in on Monday with nothing on the table, we’ll be back to the races.”
The situation is not as bad as some would have you believe – Armageddon would be worse – but it is worse than many seem to hope. Chancellor George Osborne and The Financial Times (FT) were united last week in declaring “Time is running out.”
“Intense volatility” sums up the situation on the markets. What lies behind this? Investors foresee another recession and fear a Lehman-style default that will trigger a fresh bank crisis. A default by Greece – now on the cards, possibly in early October – could bring down several European banks.
In an effort to head off that outcome, European leaders appear poised to agree a 3 trillion euro rescue of the banks as a prelude to allowing that Greek default. The fear in the markets reflects unresolved issues in the wider world, but also reflects back on them. On a grand scale that means a risk the financial markets may tip the economy into recession.
For Thomas Cook, which has its issues but is a business in nowhere near so dire a state as its share price suggests, it means a market capitalisation less than one-third its debt – and sooner or later, if things do not improve, that will become a problem.
Shares on the London market have lost one-fifth of their value since May, as have those in the US. The German and French stock markets have lost one third. These are the kind of falls associated with recession. However, one analyst notes of current interest rates (the rate in Britain is the lowest for 112 years): “[These] are not pricing in a recession but a depression.”
In essence, the debt crisis exposed in 2008 is unresolved and the growth in ‘emerging markets’ (China) that was supposed to supply the locomotive to pull the world out of crisis cannot be relied on to continue. The FTreports (£) “a sudden loss of faith in the Chinese-led growth story”.
Crazed by uncertainty, the stock-market herd stampedes first one way and then another. FT columnist John Authers noted (September 24): “There was little news this week . . . yet market prices moved as though global recession has suddenly grown much more likely.”
What economic news was there? The latest UK public finances report showed government borrowing rising faster than expected – the precise opposite of what the current spending cuts were supposed to achieve, meaning that without a change of tack austerity is likely to be prolonged.
The IMF issued its latest global financial stability report which cut growth forecasts for the UK. The minutes of the September meeting of the Bank of England (BoE) monetary policy committee (MPC) signalled quantitative easing (QE or printing money) is indeed on the way – the majority of MPC members opting for it in November, a minority for October.
As an aside, two of the UK’s leading economists – the chief economist at the BoE and the head of the Office for Budget Responsibility – greeted release of the minutes by questioning some of the more optimistic assumptions behind their own and the Bank’s previous forecasts.
The US Federal Reserve launched Operation Twist – a $400 billion programme aimed at driving down long-term interest rates (these are not high, but higher than real short-term rates which are about -3%). It had little impact, one analyst suggesting: “This simply shows the Fed is powerless against the fundamental problems facing the economy.”
And at the end of the week, the Group of 20 leading economies issued an ‘emergency statement’. Behind the scenes, all efforts are geared to preventing a Greek default delivering a Lehman-style shock to the system. Yet in the words of the FT (£): “The cavalry is not what it was. . . The world’s central bankers have been digging grimly into defensive positions.”
The FT’s assessments can be somewhat schizophrenic. In a single edition, indeed in a single column (The Lex Column, September 22), the paper noted of QE: “Get the champagne bottle ready; the UK’s QE2 could launch within weeks . . . Yet the economic issues . . . dwarf anything the Bank can do . . . QE2 will not help much.”
It also noted: “The world has started to lurch back towards financial crisis . . . The International Monetary Fund suggests the favoured solution – easier monetary policy [QE] – is part of the problem.”
Why? “Exceptionally low interest rates are building a fresh credit problem.” So we have not recovered from the last crisis and another is brewing. Worse, the FT notes: “The IMF’s convincing assertion [is] that the search for yield has driven bad credit decisions, primarily in the US.” This is precisely where the sub-prime and credit derivative crises came from.
Harvard economics professor Lawrence Summers, head of President Obama’s economic council until last year and US Treasury Secretary a decade ago under President Clinton, noted last week that the situation has shifted from September 2008 when central banks were tussling with debtors deemed “too big to fail” to one where the problem involves debtors “too large to save”.
Summers warned: “Breakdowns that seemed inconceivable at one moment can seem inevitable at the next.” We are at that stage now. Anything could happen.