Are America and Europe Sinking into Meltdown 2.0?
On August 5, the Dow had its largest single-day fall since December 1, 2008. Things were just as bad across the Atlantic, with the equivalent of nearly $80 billion wiped off the shares of Britain's 100 biggest companies.
The recent debt ceiling crisis in the U.S. produced a very inward-looking perspective among pundits and economist, and the same was true in Europe when the financial crisis hit individual countries over here. However, yesterday's stock market declines show that America and Europe are in the same sinking boat. We are no longer the different planets of Mars and Venus, to use Robert Kagan's terms. We're one and the same planet (and I'd say it was Pluto with its all its gloomy connotations).
Our mutual characteristics are mounting public debt, weak economies, rising social welfare costs in response to demographic trends, fear for the future, and (though not universal throughout Europe) gridlock in government. On the latter point, the economic crisis is polarizing politics and producing populist movements of the right like the Tea Party in the U.S., the Dutch Freedom Party, and the True Finns. If you think the U.S. has gridlock, check out Belgium—it has not been able to form an official government since June 2010 because none of the possible coalition partners can agree terms!
However the current crisis in not like Meltdown 1.0 of 2007-08—it's sparked by sovereign debt rather than private debt. As financial entities, stock markets operate through the anticipation of change. Those in New York, London and elsewhere rise at the bottom of the cycle in expectation that the economy is set to improve, and fall when things are expected to get worse, as now. Gloomy news on unemployment in the U.S., once the engine of the global economy—and even signs that the new powerhouse of China is slowing—makes the markets nervous. What's more worrying for them, however, is the solvency of nation-states. Though finally settled, the debt ceiling controversy raised doubts about the reliability of the U.S. as a borrower and the capacity of its government to deal with economic problems. In Europe, we're not looking up at a debt ceiling but down into a debt chasm in the case of Greece, Ireland, Portugal, Spain, and Italy. In 2007, the markets could draw comfort that the banking crisis did not become a sovereign debt crisis. Now, however, the signs are that it is in process of doing so. This is why investors are looking to gather as much liquidity as possible by selling off shares.
Public policymakers formed the rescue party (post-Lehman Brothers) in the Meltdown 1.0 crash caused by unwise lending by banks. Cheap money and big budget deficits on both sides of the Atlantic averted a second Great Depression, but they have not been sufficient to boost a strong recovery.
This begs the question of what policy shots are left in the locker to avoid a new meltdown. Easy money appears to have reached its limits. The first two installments of Federal Reserve quantitative easing had limited expansionary effect on the U.S. economy, so a third is unlikely to work wonders. In the UK the lowest official interest rate since the Bank of England was created in 1964 has not inspired great armies of consumers back into the nation's stores. The Obama fiscal stimulus of 2009 helped to prevent the recession becoming a slump, but it was not large enough or sufficiently well-focused to generate strong recovery. And now fiscal austerity is the order of the day on both sides of the Atlantic, which does nothing for economic growth and jobs.
In reality, however, fiscal action is needed for expansion and reflation, but the statecraft required to drive this forward is seemingly absent. As Friday's editorial in the Financial Times, hardly a voice of the left, put it, "Only politicians and the Treasuries they control have the tools to turn economic fear into hope. Their recent form is reason enough to stay scared."
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