Edward here again. I just posted this up on Credit Writedowns. I am not in the right frame of mind here to give this topic the well-developed attention it requires, but, with things unravelling in global stock markets, I feel that I have to take it on. By the way, feel free to ping me with comments on twitter too. I’m at edwardnh
At some point soon, maybe tomorrow, I will be writing an update to two 2009 posts: The Fake Recovery and The recession is over but the depression has just begun. The gist of those two posts is still operative and also very relevant, namely that the problems which created a global panic in 2008 are still with us waiting for economic weakness to reassert themselves. When that weakness comes, bad things will happen. I think that about sums it up. We are about at that point right now.
As for this post, I’ll bullet it out to be more brief and I’ll try to tamp down undue alarmism. I just had a meeting with former US President Bill Clinton. He was explaining to us why inspiring, connecting, and empowering global leaders to forge solutions on problems that are most pressing in developing countries is still relevant during these trying times. I will write this up for a future post. But his comments there reminded me about the negative impact I could have in amplifying crisis by hyping pessimistic outcomes unnecessarily. So I’ll try to keep it real but not alarmist. Tell me how I do at the end.
- The global economy hit stall speed earlier this year as Europe and the US became susceptible to a double dip at the same time.
- Double dip will likely lead to such severe turbulence politically and economically that cohesion could rip apart in a way that creates depression instead of policy support and muddle through.
- Until now, most people realised that fiscal support was lacking in both the US and Europe but they deluded themselves into believing monetary support would ride to the rescue. It will not.
- The Fed statement yesterday, while initially billed as the post-QE3 meeting statement should now be seen as the Fed reload to find its run out of ammo meeting. I should stress as I did yesterday that “it’s not that monetary stimulus is completely ineffective. It’s that you must really jam it on and you would have to target price instead of quantity to get any measurable effect and even then the transmission channel is going to be weak.”
- The Fed is not going to jam it on. “the Fed is already feeling political heat from its previous policy actions, so it will allow the economy to slip before it embarks on the next round of asset purchases. Therefore, if and when the next recession hits, debt deflation will take hold. The calls for stimulus will be deafening. And because the Fed will have resisted more aggressive prior action, the Fed will then be forced to be extremely aggressive in its policy response. That is when expanding the balance sheet will be a go and the Fed won’t just buy Treasuries, but a lot of other assets too.” [Roubini: No QE3 announcement at Jackson Hole but QE3 will happen]
- In Europe, the problem on monetary policy is the same as with the Fed; they want the fiscal agent to take on a larger role. From an ECB perspective, that means liquidity to buy bonds requires an austerity and structural reform quid pro quo from the periphery, something which is deflationary and depressionary. Unless Germany, the Netherlands and others loosen fiscal policy in turn, a double dip recession was always inevitable. [Spain’s debt woes and Germany’s intransigence lead to double dip]
- Recent data show an economy that could already be in recession. That was how the European data released today was perceived.
- Combine this with the Fed statement, which was very downbeat on the US economy and people are now panicked about a double dip for the reasons I mentioned above.
My greatest concern is the French Banks SocGen, Agricole and BNP Paribas. A wholesale funding run on these three is like a run on JPMorgan Chase, Citigroup and Bank of America in the US or HSBC, RBS and LLoyds TSB in the UK. This is major. Look at my posts on Chinese shunning trade with French banks or The European Bank Run. The French must do something. Unfortunately, that means one needs to consider not just the sovereign, but quasi-sovereign debt that creates contingent liabilities which the sovereign could be reasonably expected to cover in the event of crisis. In France, we may well see this problem crystallized next due to the liquidity crisis affecting French banks. As I see it, these banks will need a commitment from the EU on liquidity. I believe we have that. But they also need a commitment from the sovereign on capital. Look for a statement by the beginning of next week.
And, yes, I still do have hope even now that policy makers will get it right and prevent worst-case scenarios. But, the number of different upside outcomes has dwindled the longer this crisis has proceeded. I will leave it there for now. I don’t have a ton of trading ideas here. Right now, it’s a liquidity crisis, a panic, and it’s all on policy makers. Good luck in the markets.