The next crisis moment
By Cees Bruggemans, Chief Economist of FNB.
Global financial markets again sold off massively and en masse today, giving up all the comeback from last week’s widespread panic conditions.
There are at present two major sources of potential market crisis and panic, namely US finances and European sovereign debt and banks.
The ultimate conflagration would be the one crisis feeding the other in a mutual-assisted suicide.
That has not been quite the situation to date.
The Anglo-Saxon banking crisis came first (2007-2008) and after a decent interval followed the Eurozone sovereign debt and banking crisis from late 2009 onward.
But as we saw in early August when US debt ceiling and rating downgrade dynamics interacted with European sovereign debt and banking rumours, financial markets can quickly set in motion panics that jump oceans.
So what’s left that could still give solid panics?
It is primarily US politics misusing the national finances and financial markets disagreeing with European political solutions to their debt problems that form the main crossroads.
The US debt ceiling may have been safely lifted, enough so for it not again to be an issue until 2013 after the US election is out of the way.
But between now and then a few really contentious decisions need to be made.
As part of his bid for a second term, President Obama will want to make progress in reducing the US budget deficit, putting it on a more sustainable trajectory for the long haul, and doing so specifically by raising the taxes on the well-off.
Simultaneously, he will not want to cut government spending too much from fear of weakening an already feebly growing US economy.
The answer here is to let the Bush-tax cuts on the better off lapse by early next year (with nine months to go to the election), while extending unemployment benefits for the many hard-up Americans, while also selectively boosting infrastructure spending (bringing forward what in any case needs to be done).
Adroit stuff indeed, preventing a 1937-type premature relapse into (major) recession if fiscal support were to be withdrawn too soon in these very trying times, but still ensuring a more ‘normal’ tax burden (from present exceptional low levels near 14% of GDP) positioning the national finances for a long-term return to health.
So far the President.
As part of their attempt to gain control over both House and Senate as well as the Presidency, the Republicans are positioning themselves for blocking any move to let the Bush tax cuts lapse and the tax burden rise, while being strongly against increases in government spending (indeed in favour of cutting them).
That the US economy could slide heavily into recession as a result by Election Day and be an embarrassment to the sitting President is loudly denied.
So have we got here another wonderful grandstanding opportunity, where the rest of the world is driven to drink as it has to watch Republicans and Democrats disagreeing with each other as to what needs to be done, until President Obama agrees to extend the Bush tax cuts to 2013 and the Republicans agree to extend unemployment benefits?
But what if this time it really is “over my dead body”?
The US tax burden could do with some lifting for the long run, and letting the Bush tax cuts lapse on those earning over $250 000 would be a good down payment in redirecting the US finances longer term.
But it would be disastrous for short-term economic prospects if the Republicans were not to be agreeable to extending the unemployment benefits and other spending, for their direct hardship relief, but also for what it would mean for the broader economy if effective demand were to take a nosedive.
A horse-trading opportunity made in heaven, you will say, but so much political capital was lost with the debt ceiling compromises (rather than the last minute dithering) that THIS time there will be less compromise (cross my heart that I may die if it ain’t so).
As we saw two weeks ago, it was perhaps not so much the US debt down grade or the EU banking antics that had markets really hopping as the fear that a serious slowdown was in the works and not priced in.
That, mind you, with temporary headwinds having had a hand in the slowing, with some rebound likely, even if only modestly so.
One shudders to think if a 1937-type premature fiscal withdrawal of support were to come into focus, causing an abrupt US descend into recession from present already excessively high pain levels (29 million Americans being unemployed or underemployed – 20% of the labour force).
If enough people around the world were to become cautious ahead of this momentous event, it could cause spending and output to fall off even BEFORE the US politicians had pulled the ripcord on themselves.
Over in Europe, a number of countries are either severely cutting their fiscal deficits back (primarily by cutting spending, the growth-friendly approach as opposed to raising taxes). And a few (Spain, Italy, France) had markets give them the once-over in recent weeks, prompting alarm and quick decisions about yet more frugality, in the process heightening slow growth and even EU recession fears.
But if fiscal frugality isn’t quite the fearful thing it is in the US, in Europe it remains sovereign debt spreads and bank funding needs that are at risk.
With EU political leaders slow in crafting solutions to debt, governance and growth quandries according to what their electorate traffic can bear, markets are easily prompted into panic withdrawals from overexposed assets.
When rumours start flying, financial defences inadequate and politicians slow-acting, a spark can ignite the whole edifice in a moment and the resulting panic then jump the Atlantic via financial banking channels (still the most exposed to counterparty suspicions).
There is really little new in any of this.
Instead, it involves revisiting old scar tissues barely healed, and doing so again and again, for politics is yet to square fiscal circles on either side of the Atlantic, a process of years, or to get growth going again meaningfully.
Of course politicians can be expected to forgo exploring the maximum stretch in any proposition for all trade-offs are difficult, the present-day existential ones especially so.
But just so are financial market participants justified in asking the nature of any compromises made, and at whose expense mostly. Where the looming price to be exacted looks large, and the risk of it happening real, one can expect quick withdrawals from the danger zone, in its final moments even creating a self-feeding panic.
America does not have to slide back into recession fiscally-assisted and Europe need not face funding black holes from forming and banks folding. But if the safeguards are not forthcoming these events have a way of coming into being, whether actively betted on or simply due to raw flight from danger.
Have we seen the last great panic of these Western crisis resolutions? Probably not, given the potential for political havoc. Indeed, last week’s panics may be starting up again, not having really gone away.
It makes for volatility in markets, potentially massively so at times. This should keep monetary policies accommodative and precious metals and other safe havens favoured.
South Africa should remain a net beneficiary of these global events provided nobody succeeds in pulling down the pillars supporting the global roof.
Source: Cees Bruggemans, FNB, August 18, 2011.
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