At the time of writing this article—a little before 1am on Monday morning Singapore time—there was no major announcement from Europe. Of course, since the summit meetings have been extended until Wednesday, it is not possible to expect an announcement now. Reuters reports that the European Union has “began a crucial two-leg summit called to rescue the euro zone from a deepening sovereign debt crisis. The aim is to agree by Wednesday on reducing Greece’s debt burden, strengthening European banks, improving euro area economic governance and maximizing the firepower of the European Financial Stability Facility (EFSF) rescue fund to stop contagion engulfing bigger states”.
That the summit declaration would come on Deepavali day is an interesting coincidence. Some firecrackers exceed expectations and some go down with a whimper. The funny thing is that whatever financial markets would deem as an explosive success has the potential to turn growth into a whimper down the road. A plan or a promise to boost the EFSF, write off Greek (and other countries’?) debt and recapitalize banks might be deemed by financial markets to be a spectacular success. But it would be kicking the can down the road and, as a friend shrewdly observed, each kick is getting weaker and weaker. At some stage, the can will not move.
Unemployed Greeks wait in a long line at a state labor office to collect benefit checks, in Athens, on Monday, 24 October, 2011. Photo by AP.
Contrary to expectations, October has seen financial markets embrace risk with gusto. Clearly, at the margin, there has been some improvement in economic data out of the US. Retail sales in the US grew strongly. The Housing Market Index (confidence index among home builders) improved a bit and the icing on the cake was the strong and unexpected rebound in the regional manufacturing index of the Philadelphia Federal Reserve District.
Also Read | V. Anantha Nageswaran’s previous columns
But we know that financial markets do not have the patience to grasp the meaning of some of these economic indicators and the dynamics that they imply for the broader and long-term economic health of the US. Retail sales might have gone up, but in real terms, they are declining as most of the improvement in retail spending by households reflects inflation. US import price inflation is in double digits and producer price inflation is in high single digits. The erosion in purchasing power of the US household is ongoing. A rise in the cost of living compounds the weak labour market situation with weak job creation and non-existent wage growth.
Into this milieu, kites are being flown on targeted relief to mortgage borrowers. Obviously, the US government is in no position to provide relief to them. It is not clear if it could risk doing that without further jeopardizing its credit rating or if there is political consensus behind it. The stage is set for the Federal Reserve chairman to make a grand reappearance with freshly serviced dollar printers.
There is a concerted attempt to swing public and political opinion in the US in favour of further monetary policy adventurism by the Federal Reserve. Daniel Tarullo—a Federal Reserve governor who has never voted against the Federal Reserve chairman—said, “The central bank should consider resuming large-scale purchases of mortgage bonds to boost economic growth and help combat a ‘crisis’ in employment.” Janet Yellen, vice-chairman of the Federal Reserve, has opined that “a third round of large-scale securities purchases might become warranted if necessary to boost a US economy challenged by unemployment and financial turmoil”. Lawrence Summers has shot off an opinion piece in The Financial Times on how the mortgage sector is holding back the recovery. One of his prescriptions is that the Federal Reserve should buy more mortgage-backed securities. The “Tea Party” has not managed to put the inflationists and the reflationists to rest with finality.
The consequences for the world will be bad. Inflation all over the world is rising and policymakers are pulling wool over the voters’ eyes by harping on deflation. It is not evident in the developed world, let alone emerging markets. We are stepping into a world of inflationary non-growth from the world of non-inflationary growth that we got used to in the 1980s and 1990s. That brought gains to investors. The brave new world of inflationary non-growth is ushering social discord and conflicts between citizens and the state.
Investors buying into risk now are repeating the mistakes that they have often made in the past. They are confusing hyperactivity with policy dynamism. A true measure of risk for the current situation is the additional premium that investors demand for holding French government bonds over German bonds. That has been rising relentlessly. Investors are devouring irradiated assets.
As my friend and fellow columnist Narayan Ramachandran has observed in a different context, inactivity is the most difficult thing to practice. It is the evolutionary touchstone for individuals and investors.
V. Anantha Nageswaran is a senior economist with Asianomics. These are his personal views. Your comments are welcome at firstname.lastname@example.org