Yesterday was another very bad day in stock markets. It was the day when investors and investment managers let out a great cry for help. It was the day they decided the west’s political leaders had no answers.
The immediate cause was the results of the two day Fed meeting to consider the crisis and what to do next. The Fed decided to do very little. It announced no new great money printing scheme. There are to be no fistfuls of extra dollars to push up asset values.
They did say they would sell some short term bonds, and buy some longer bonds. They did say they would use the proceeds from repayments of mortgages they own to buy some more mortgages. They also said the economic outlook was poor.
Clearly it was not enough for the optimists still left in the market. They had been hoping that the Fed would have a new magic bullet. They hoped the Fed would have a way of puffing up the economy again.
Markets had come to realise the US President cannot deliver his package to boost the economy by spending more, taxing more and borrowing more. Nor do they think such a package would work anyway. They also know the Republican package of spending less and taxing less is stillborn. The balance of the US constitution has delivered a log jam at the top, when people want decisive leadership.
The biggest falls took place in Euroland. There no-one speaks convincingly for the Central Bank. The Bank often has to pursue its policies by stealth, for fear of upsetting the prudent ones led by Germany. The leading politicians of Euroland are in disagreement with one another. They cannot decide whether to print more or borrow more to tackle the heavy debt problems of Greece and Portugal, Italy and Spain. They say they do wish to keep all the problem countries in the zone, but do not communicate a vision on how that is possible.
The Euro remains an orphan currency. It is in search of political parents to love it and take care of it. It needs a sovereign to tell it what to do. It needs a grown up Central Bank that has clear views on how much to print and how much support to offer the commercial banking system.
At the heart of the crisis unfolding is too much debt.In the first phase of the crisis in 2007-8 the problem was too much private sector debt. Banks had borrowed too much. Banks had lent too much, especially against property in the US, UK, Ireland, and Spain. Governments eventually got over the worst of this by taking many of the debts of the banks onto their own balance sheets one way or another. They also decided on a reckless expansion of their own borrowing, to stave off the full adjustment.
Now, the second phase of the crisis is on us. In this phase weakened banks lend money to heavily over borrowed governments, and spendthrift governments lend or spend money on propping up the weakened banks. We have often talked here of the dangers of this arrangement. The Regulators have made the banks lend more to governments, claiming this is risk free. The governments have often propped up the banks, without demanding action to sort them out.
So what should be done? The governments and banks both have to get their houses into order. For the governments, that does mean spending less . You cannot get out of a debt crisis by borrowing more. For the banks, that should mean quicker action to sell assets, write off liabilities, break up weak conglomerates, raise new capital until each main bank is trusted by the market.
None of this is easy. The sooner the adjustments are made, the sooner we can resume decent growth. There is no safe way left to kick the can down the road. Print more cash and you will get more inflation. Borrow more, and you will undermine markets further. Pretend and extend more credit, and you continue the gnawing erosion of confidence.
Yesterday the World Bank, the IMF and some of the leaders of the west made statements telling us things are bad, but saying that someone else needed to take action. The US Treasury Secretary has urged Euroland to sort itself out, but has to admit the US can’t settle on a single policy either. Euroland keeps delaying decisions, as individual countries make heavy weather of even implementing what the zone agreed last July. There is a lot riding on the G20. In the end it will come down to individual countries sorting out their own budgets and tackling the problems of their own distressed banks. Those who do so convincingly will get a better ride from the markets than those who hope the problem will go away if they ignore or simply hire more spin doctors.