“You can ignore reality, but you can’t ignore the consequences of ignoring reality.”
– Author unknown
What a horrible week for the global economy where bad went to worse and solutions went to outright panic. Central planners in Europe opted to not allow price discovery as the truth was something they nor fragile markets in their view could handle. Reality was introduced to the historical benchmark for risk free investments while the parallels to 2008 financial meltdown grew.
The Benchmark For Risk Was Downgraded
The triple A rating of the US government is no longer. The dominance or perceived dominance of the US throughout the world moved down another notch. This is not the end of the US but hopefully a wakeup call to the reality of how the world views our financial security. As Jim Grant recently stated the US has been using a credit card when we really need a debit card.
In the short term interest rates actually fell as economic woes offset the risk of investing in a lower quality credit. Long term though this will not be the case and unless something is done the solvency of the US will become a global risk. A simple 100 basis point rise in yields will result in $1.4 trillion in interest expense over 10 years (a time frame politicians love to discuss savings).
Rather than confront this downgrade as an opportunity for real change political leaders name called the rating agency while congress demanded an investigation into insider trading allegations with S&P to senate hearings where congress could stand on their soap box at the expense of reality.
The Fed’s hand was shown and QE is a tougher sell
There is a lot of debate as to whether the recent FOMC statement was stealth QE, was “operation twist” which targets 10 year yields or was a huge gift for equity markets. I view it very simply as the Fed downgraded the US economy while showing that QE or any version thereof is not an easy sale. With three dissenters the blank check for Chairman Bernanke was taken away. Should the economy deteriorate at an accelerated pace and should deflation rear its ugly head then the Fed will launch QE3 of the old school asset purchase design.
For now though the Fed said they will not touch rates before the presidential election but offered nothing else. If low rates could stimulate the economy we would have growth three years after they were reduced to zero. Instead we have nothing but asset bubbles galore, a weak US dollar which has not and will not help US exports on its own and structural changes still not addressed.
The US Entered Economic Recession
Others would say there was never a recovery so recession was never in question. Regardless of the term used the economy is in contraction. It will take over a year possibly before Q2 GDP is revised negative as was the case with Q1 2008 that started the “not so great” recession.
The death knell though was sounded on Friday with a 30 year low in consumer sentiment which correlates with everything from consumer goods to manufacturing data to investment and much more.
The Global Economy Slowed
The global growth story is in decline. As the US begins the next leg of economic contraction it is not alone. From China battling rising inflation to the realities of austerity across the globe economies are contracting and in many cases at a faster rate than most had anticipated.
French GDP was 0.0% in Q2 from 0.9% in Q1
Japan lowered fiscal GDP estimates from 1.5% to 0.5%
China PMI was 50.7 in July down from 50.9 in June where 50 defines expansion (above) or contraction (below)
UK GDP was 0.2% in Q2 down from 0.5% in Q1
The Calm Before The Storm
And through it all the equity markets are in a peaceful and tranquil state where truth is ignored for the pain of reality is too great.
Republished Under Licence
Macro View August 15, 2011- Macro Story.
Images: Flickr (licence details)
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