In ‘America and Europe Are On the Verge of Disastrous Recession‘ by Roger Altman, the former US deputy Treasury secretary under President Bill Clinton, argues that we are toying with fire. According to the author, we are dangerously close to another Lehman disaster. He points at several indicators to make his point, namely the very low long term interest rates on U.S. government securities.
Yet, what worries me the most is the following: When the Lehman collapse occurred, the market’s reaction took us by surprise and it is this situation of being caught off-guard that created the subsequent crisis which then triggered the massive and improvised Fed intervention that followed. I believe that the intervention was necessary to save us from falling into the abyss, although 1. I hate the idea that we saved bankers who were responsible for creating the crisis in the first place and 2. I also believe that the fiscal piece of the bail-out was botched and explains in large part why we are still deep into a jobless recovery.
A positive observer might claim that while we are still stuck in a quack mire of gigantic proportion, at least our arsenal to fight destabilising events is ready for action. According to this view, a Lehman type event could not happen today (or would not have the same effects) as authorities would stand ready to intervene to prevent a panic that could give rise to a collapse. Also, strong from the experience of having recently juggled with difficult crisis successfully (at least from the point of view of having avoided a total collapse of the economy), policy-makers stand confident and make us feel safer than we would otherwise given the dire situation we are currently facing, especially in Europe.
But what if there was another destabilising event of another nature than a Lehman collapse? What if such event caught us off guard again? In other words, what would happen if there was another Black Swan? Would we have the resources and the imagination to pull it off once again? Would we find the tools and solutions to succesfully fight the crisis and to overcome the panic that could ensue? We can’t be that sure that we would but we prefer not to think about it.
If the worst scenario is finally going to unfold, we will need to finally reflect on what happened to, in the end, realise that we just can’t just go on as if nothing happened for the last 15 years. We will have to wake-up from this fairy tale gone wrong. Most of us have our heads on the sand, wishing that this crisis never happened or that it will just go away if we only treat its symptoms. But the reality is that it won’t.
Until we treat the real causes of the crisis, it will linger and the risk of a huge relapse will remain. It is only by purging the system of its rotten core of entrenched interests that we will be able to reignite the entrepreneurial spirit of our people. Less taxes and less regulation was supposed to unleash such spirit and convince us to work harder because we could reap the rewards of our efforts rather that seeing them being taxed away or dampened by the burden of red tape and bureaucracy.
It work for a while. But something went awfully wrong at one point when we stopped paying attention. It happens all the time when there is a revolution. It starts with good intentions and works for a while. But as some people think more about the game itself rather than simply playing it, they are eventually able to rig it in their favour at the expense of the rest of us. This was the case before Reagan’s revolution and explains the crisis of the seventies and it is the case again today. Except that this time the solution to the current crisis will be harder to find. A good charismatic leader that would reverse the course of history may have a tougher job to do today. Now that globalisation has weakened a sovereign nation’ ability to act to reign in the excesses that are apparent to all but that are the strongly guarded privileges of a few we are in for a real fight.
Obviously, we need to re-establish fair rules for the game of business that we played so successfully for generations. Lower taxes and deregulation a few decades ago helped ignite entrepreneurs to take risks in the eighties and nineties. Today, re-establishing a more levelled playing field is the only way to convince the next generation of entrepreneurs to jump in the fray and make this economy grow again. If most of them remain convinced that the game is rigged, why would they play? They will remain on the sideline.
Here is the piece published yesterday in the A-list blog of The Financial Times:
Interest rates on US, German and UK government bonds have fallen to all-time lows. Yields on 10-year US Treasury securities, for example, are below 2 per cent. That is the lowest recorded since the Federal Reserve began publishing market data in 1953. In addition, yields on the inflation-protected 10-year Treasuries are zero. These are almost incomprehensible levels whose implications are profoundly negative. Namely that Tuesday’s International Monetary Fund report is quite correct to warn that America and Europe are on the verge of renewed recession. It is only the anticipation of negligible demand for capital and negligible inflation – both hallmarks of recession – that could drive rates this low.
For the American and western European economies to decline again, when unemployment levels are already so high, would be disastrous. It would shock consumers, businesses and financial markets. Fearful, they would retrench further, causing the economic decline to accelerate. Weak labour markets would worsen as would the already swollen government deficits and debt. Overall, we could be in for a repeat of the experience of 1937, when America fell back into recession after three years of recovery from the Great Depression.
How do we know that another recession is approaching? For starters, there is no other credible explanation for the relentless fall in interest rates. Yes, monetary policy is on maximum ease and that controls short-term rates. Safe haven psychology also is at work. However, these cannot explain such low yields on longer-term government and corporate bonds. Further, bond markets usually signal recession through an inverted yield curve, when long-term rates are lower than short-term ones. Technically, this is impossible now given short-term rates are zero. But the recent movement in long-term rates is the equivalent.
Moreover, recent US and European economic data convey serious weakness. US household net worth has begun to fall again and jobless claims have been rising for several weeks. Retail sales are flat and consumer confidence is hovering around modern lows. Onshore corporate liquidity has reached a record $13,000bn, which signals that businesses are uncertain over the outlook.
Across the Atlantic, the trend is also poor. Neither Germany nor France grew in the second quarter. Household consumption in the eurozone actually fell during that period. Moreover, the European Commission is forecasting only 0.2 per cent and 0.1 per cent growth across the region for the third and fourth quarter respectively. The worsening of the sovereign debt crisis surely means that actual results will be worse.
It is the debilitating sovereign debt crisis in Europe that is pushing both regions back towards the brink. It is causing credit conditions to tighten again for sovereign credits, weaker borrowers and small and mid-sized business. It also is suppressing consumer and business confidence and the export outlook.
The never-ending nature of this crisis was avoidable. At every opportunity Europe’s leaders have delayed, taken the tiniest steps possible and generally averted their eyes to the elephants in the room. Yes, everyone knows that the country-by-country politics are difficult, starting with Germany. But the risk of another Lehman-like market collapse and subsequent economic contraction is huge. Faced with this, European leaders must confront the politics. Instead, their grudging incrementalism is deepening the risks. Implicitly, this was the message behind Treasury Secretary Geithner’s presence in Poland last week.
A single currency representing 17 separate nations inevitably requires a unified balance sheet behind it and, following that, a form of fiscal union. The time for denying the latter is over. The European financial stability facility must be enlarged exponentially so that it can stand behind nations such as Italy or Spain. In addition, the mandate of the European Central Bank must be expanded. Just like the Federal Reserve, it should be responsible for maintaining a sound banking system and stable capital markets. This requires a permanent capacity to finance banks directly, just as a group of central banks did last week. It also requires the flexibility to buy and sell sovereign debt securities in secondary markets. These reforms must be accompanied by tighter, eurozone-wide bank regulation and supervision. It also requires IMF-like conditionality to accompany direct EFSF loans to member nations. Finally, the ECB should ease monetary policy now as there is no visible inflation risk.
America also must stop its own partisan bickering and undertake one last round of fiscal stimulus. The $447bn job-creation plan by President Obama, or another quick-acting plan of similar magnitude, should be enacted immediately. The Fed should also initiate further moves to promote credit availability and lending.
Another recession would be profoundly damaging to labour markets and public confidence. It would take years to fully overcome. We must try to avoid such an outcome at all costs. That requires the type of far-sighted leadership that we haven’t seen much of lately.
From The Sceptical Market Observer: Could We Be on the Verge of a Collapse?.
Images: Flickr (licence attribution)
About The Author – Luc Vallée
Currently President of The Independent Market Observer. Chief Economist and Vice-President at the Caisse de dépôt from 2001 to 2008. Chief Financial Officer and Vice-President, Corporate Strategy for Mediagrif Interactive Technologies from 1999 to 2001 – MDF.TO. Deputy Treasurer at Canadian National Railways, 1997-1999. Associate Professor of Applied Economics at l’École des Hautes Études Commerciales (HEC) in Montréal, 1989-96. Consultant for the World Bank, the Canadian government, the Quebec government and the City of Montreal. Deputy director of the Center for International Studies, 1993-1996. Adviser to the investment banking division of Société Générale in Canada, 1996. President of ASDEQ in 2005-06. Member of the National Statistics Council of Statistics Canada, 2008-now. Ph.D. (1989) in economics from the Massachusetts Institute of Technology.