Global stock markets have clearly been underwhelmed by the passage of the law that will allow the US government to spend $700 billion to bail out troubled banks in that country. Stock prices fell on a day when the US Congress approved the reworked Paulson plan.
Illustration: Jayachandran Nanu / Mint
There are two good reasons for this insipid reaction, as the crisis has spread wider and deeper into the global economy. First, financial problems have now jumped across the Atlantic. Several banks, such as Fortis Bank, have been nationalized and French finance minister Christine Lagarde has floated the idea of a rescue fund for the European financial system. Second, the problems that started off in the balance sheets of financial entities in the US have spread into the real economy there. The US labour department said on Friday that the economy shed 159,000 jobs in September, the largest drop in five years. Housing prices continue to decline.
While the US is not yet officially in recession, it is dangerously close to one. And a lot worse could be in store for it. The International Monetary Fund, or IMF, said on Friday in an advance chapter of its semi-annual World Economic Outlook, or WEO, that the world’s largest economy is headed into a severe recession. Europe and Japan are unlikely to buck the trend. They, too, have been reporting anaemic growth. In sum, the world economy could be headed for a patch of rough weather.
Government bailouts in the US and Europe will be costly — and perhaps ineffective. They will also damage national finances, especially in the US. Meanwhile, there is a deep aversion to risk-taking right now, as is evident in benchmark interest rates, the implied volatility in the options on major stock indices and the spreads between US treasurys and the London interbank offered rate.
The animal spirits that encourage traders and entrepreneurs to take risks have been suppressed. The loss of confidence in financial systems cannot be quickly overcome with government spending and low interest rates. Japan’s decade-long battle with recession is a sobering case of post-bubble stagnation.
A sharp V-shaped rebound in the world economy seems more unlikely by the day. That is perhaps why battered stock market investors have been unimpressed by large bailout plans.
How close is the global economy to a full-blown recession? Write to us at firstname.lastname@example.org