Tel Aviv brokers.
(photo credit: REUTERS)
A few days of sharp gains and a few more of relative stability, following the severe sell-off in global markets that ended on August 9-10, was enough to renew hope in the hearts of the eternal optimists. But all that this hiatus provided was an opportunity for the battered to withdraw and the foolish or greedy to rush in. After some weakness on Wednesday, the markets simply collapsed on Thursday.
Yet it must always be stressed that the equity markets are not what really matters; they are merely the easiest to follow and hence function as a barometer used by the media and the general public. The true focus is the credit markets, where money is lent and borrowed. These include bond markets (government and corporate – and, in the US, municipal and state) and the money market, where short-term deposits and loans are transacted.
The government bond markets have been in the spotlight, thanks to the intensifying crisis affecting more and more European countries. In the US, the worsening woes of states (California last year, now New Jersey), counties (who ever heard of Jefferson County, Alabama, before its descent into imminent bankruptcy?) and cities has been covered in the financial press, if not in the headlines.
But the main arteries of day-to-day financial activity are the money markets, especially the interbank markets where financial institutions lend and borrow vast sums, every hour of every trading day, around the world. If we go back to the events of 2008, the point at which the global financial crisis became a global economic crisis was when the money markets seized up and stopped functioning, because banks, insurance companies, etc. stopped doing business with each other.
That happened because, after the collapse of Lehman Brothers, they felt
unsure they would see the money they were lending today being repaid
tomorrow, let alone next week or next month.
The 2008 scenario is playing out again in the European money markets –
this time without the spur of a specific, Lehman-esque event. The
European banking system has been suffering from a steadily worsening
liquidity crisis, which is why the shares of European banks have been
plunging, leading the rest of the equity markets downward.
The slumping bourses are merely the symptom of the problem in the
banking system. But the ultimate cause of the banks’ problems is the
fall in value of the government bonds that comprise so much of their
asset base. The result is a vicious circle of market declines that feeds
on itself. But it is when the banks stop lending to each other that
normal commercial activity is impacted and the entire economy grinds to a
The similarities between the crisis playing out now – with no respect
for August being the vacation season of most of the developed world –
and that of 2008 beg the question of whether the response from the
world’s major economic powers will be the same. In one key respect, the
answer is definitely no: China will not repeat the massive stimulus,
amounting to 15 percent of GDP, that it injected into its economy
following the 2008 collapse. It will not, because it doesn’t have the
resources to repeat that trick – and also because the Chinese economy is
still suffering the negative side effects, notably inflation, that that
The US will also not launch a large fiscal stimulus. President Barack
Obama probably would if he could, but given the Republican control of
Congress and the extremist control of the Republican Party, there is no
chance of fiscal largesse. On the contrary, the thrust now is for fiscal
retrenchment, and the argument is over how much.
That leaves monetary policy. Interest rates are already very low in most
countries, but central banks have stressed that they are willing and
able to take further measures to ease monetary policy. The Bank of Japan
is aggressively buying Japanese government bonds, the European Central
Bank is buying Italian and Spanish government bonds every day, the Bank
of England is mulling another round of bond buying, and the Swiss are
intervening to try and stop the Swiss franc’s rise. That leaves the
Federal Reserve, which ended its second bond-buying program in June but
has made clear its readiness to begin another one, if the economy
The latest batch of economic data from the US and around the world makes
clear that the American and global economies are sinking fast. It would
therefore be no surprise if Fed Chairman Fred Bernanke announced next
week that the Fed was stepping back into the fray. However, it would be
more surprising if this move provided anything more than temporary
support for the crumbling global financial system.
Confidence has cracked across the board, and the failure of the Fed’s
policies over the last two years has eroded confidence in its
once-unquestioned ability to impose its will on the markets and through
them on the economy. That loss of confidence is now the critical factor
at work, because the realization that policy makers’ efforts last time
bought so little gain for so much money undermines everything they say
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