The sharp break downwards in global markets towards the end of last week is an expression of strengthening concern that the global economy is slipping back into recession.
It is actually more than that. It is clear the markets are also fearful that what was a sovereign debt crisis in the eurozone is also building into another financial crisis. One of the factors in the sell-off has been reports that a European bank, unable to get funding conventionally, was forced to ask the European Central Bank for $US500 million of emergency funding, raising the spectre of another Lehman-like event.
With the gold price rising and just about everything else falling – US treasuries towards record lows – it is obvious that real fear is again abroad and, given the daily demonstration of the inability of Europe to develop a plan to eventually get its house in order, and the recent evidence of a similar failure of the political system in the US, there is good reason for the markets to be fearful.
The panic evident in markets towards end of the week was initially triggered by investment bank downgrades of the outlook for global growth and then compounded by the reports of a European bank in trouble.
The surprising aspect of the reaction to the downgrades – the key one appears to have come from Morgan Stanley – is that anyone was surprised. It has been evident for weeks that another recession was looming in Europe as it became increasingly apparent that its policymakers are failing to deal with the eurozone’s sovereign debt issues and that signs of life in the US economy have been faltering.
The ECB’s purchases of bonds issued by some of Europe’s more deeply stressed sovereign issuers brought only momentary relief. Europe needs some form of structural solution – whether it’s the issuance of Eurobonds to socialise the sovereign debt issues across Europe or some other bailout of southern Europe by the Germans or some other means to the same end – not another batch of Band Aids.
It needs it soon. What was a sovereign debt crisis does threaten to blow up into another banking crisis.
Unlike the US, where at least most of its key banks have been properly recapitalised, the European banking system has been slower to address the structural weaknesses exposed and exacerbated by the last crisis, perhaps hoping that growth would reduce the scale of the task.
Its stress tests have been less demanding and less honest – everyone who looked at the results of the latest tests earlier this year knew there was an implicit asterisk associated with them in the form of the banks’ exposures to sovereign debt. Had the risk of defaults been factored into the valuation of those holdings many, if not most, of the banks that passed the tests would have failed them.
The risk of the sovereign debt crisis flowing into a European – and inevitably global – banking crisis of far greater proportions than experienced in 2008 is real and will be latent in the system unless and until the Europeans agree on a plan to stabilise those economies now undermining the entire eurozone and causing chaos in markets.
The markets have lost any confidence in the ability of policymakers in Europe – and politicians in the US – to properly tackle the challenges. That loss of confidence is being manifested in extraordinary levels of risk aversion by investors, consumers and corporations. If that isn’t reversed it will be self-fulfilling.
The extent of the messes, and the debt burdens, that have developed in Europe and the US makes it unlikely that, even if pathways to eventual stability are developed, there will be any near-term return to anything other than anaemic growth. It is also probable that the structural challenges and the weaknesses in those economies and in the European financial system will produce regular outbreaks of volatility and rekindled anxieties in markets.
With no obvious or painless circuit breakers in the foreseeable future, long-term austerity – a decade of Japanese-like economic winter – appears the most likely best-case outcome.
This article first appeared on Business Spectator
James was the editor and publisher of SmartCompany and LeadingCompany for five years. He is now the Australian Financial Review‘s companies & markets editor, and a former BRW editor.
