Duncan’s Economic Blog

The Grim Global Outlook

Posted in Uncategorized by duncanseconomicblog on August 3, 2011

A very quick ‘major economy’ round up.

The Eurozone crisis is getting worse. Spanish and Italian bond yields are at Euro-era highs and the market is increasingly focussed on worries about the Italian banks.

The divergence can also been seen in the spread between French and German bonds hitting a Euro-era high.

In the US, the debt deal may have passed, but a bad manufacturing PMI and awful consumer spending numbers have revived fears of a double dip recession.

As investors flee to safe havens, we risk round two in the ‘currency war’ as Switzerland attempts to devalue the Swiss Franc which has been driven by its ‘safe haven’ status.

Meanwhile, domestically, the outlook is grim.

Against this backdrop governments from London to Washington to Berlin are committed to cutting government spending and austerity.

What is now worrying me is that we may be verge on a major financial crisis – one not based on ‘too big too fail’ banks on but ‘too big to save’ Eurozone states – and unlike in 2008 there is little evidence of intra-government cooperation and no appetite amongst policy makers for a stimulus programme.

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8 Responses

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  1. jomiku said, on August 3, 2011 at 2:45 pm

    If there is another financial crisis, the mechanism would be different. The immediate cause of the last one was a chain of events that started with the Lehmann failure. They were one of if not the largest money market funder. The US Treasury was unaware – or severely underestimated – that European banks were using US money markets for short-term funding, meaning as a source of US dollars. Supply of dollars dried up and every bank tried to grab those it could, which was then directly reflected in Libor and other indicators of bank to bank trust. The US Fed made an overnight loan of something like $630B to the ECB to inject dollars but it wasn’t enough and was done too late. I’m getting this info from a couple of papers put out by the BIS after some months of untangling what happened. London’s secrecy rules attract capital flows. This was a cost to the system of that. Yes, the market participants should have prepared better – some likely did but not enough did to matter. Yes, they believed Lehmann would be bailed out. No, it appears they didn’t know everyone else was doing the same thing and had the same kind of exposure. That is a big reason why credit trust between banks disappeared.

    What would be the mechanism this time? Write down of capital because of larger failure than Greece? Italian banks would go down if Italy does because they are heavily, heavily the owners of that stuff. The question might be: what would cause a near complete lack of credit trust between bankers? This could happen if banks start to topple but it wouldn’t be the same liquidity crisis as the last time so it wouldn’t play out exactly the same.

  2. metatone said, on August 3, 2011 at 3:25 pm

    To round out the picture there are suggestions that the Chinese construction/real estate bubble may be reaching a popping point, which would really put the pressure on.

  3. Dave Holden said, on August 3, 2011 at 6:25 pm

    2008 was a solvency crisis. The powers that be did their best to hide the fact it was a solvency crisis with bank bailouts and endless delays in mark to market accounting but part of that process was moving risk onto government books. Now 2011 we have a sovereign solvency crisis so one wonders how they’re going to hide this one.

    So again it’s debt that can’t be paid back that is the problem until that is addressed we will continue to pour good money after bad.

    Medium term the most coherent approach I’ve see as both a way to reduce debt and ultimately transition away from debt based money is coming from the positive money guys. http://www.positivemoney.org.uk/

  4. jomiku said, on August 4, 2011 at 5:21 pm

    Again, the solvency crisis was caused by the failure of property markets AND the failure of models to value properly the long-tail risk of such a complete failure of property AND the failure of the highest level tranches of carved up property related debt, the ones believed to be ultra safe, AND the failure of what were believed to be iron-clad hedges. If we merely had a solvency crisis, if it were simply that Wachovia and Merrill owned too much crappy debt (most of it not subprime), then those companies would have been folded into survivors without needing much government assistance. It was a complicated mess.

    I’m sorry but I get frustrated when complex things are abstracted until the meaning is gone because that prevents thinking about the current situation with clear eyes. If there is a solvency crisis now, it would need a reason to spread as a contagion. Italian debt is mostly held by Italian banks. Do these banks play large enough role in the larger economy – through trades, etc.? Do Spanish banks? Which ones? Is Santander an issue because that’s more important than regional banks? These are the questions we should be asking.

  5. Dave Holden said, on August 4, 2011 at 9:23 pm

    Well I haven’t spent months untangling “the details”, so I’ll defer. But add from my “abstracted” view the banking crisis was and is ultimately one of solvency. The sovereign crises depends on the country so in that I agree I was being too “abstract”.

  6. gastro george said, on August 4, 2011 at 11:06 pm

    Isn’t solvency just too simple an argument, whatever? Italy is “solvent” at 3% for it’s bonds but “insolvent” at 6+%. But what’s the real difference? Just because a set of vampires have bid up the price, then Italy is suddenly insolvent? The real reason has to be deeper than that.

    • Dave Holden said, on August 5, 2011 at 6:37 pm

      For some countries solvency issues are medium term and here liquidity may help. For others (I would suggest at least Greece and Ireland) it very much is a case of solvency. In the case of banks there’s no question in my mind its a solvency issue. They’re up to their gills in dogdy loans. What’s worse is that asset prices in some countries have further to correct. So for example the UK I would suggest housing has another at least 20 percent to fall. The Economist price/rent calculation puts them as still 30 percent overvalued. You can see why banks are against mark to market accounting.

      • gastro george said, on August 6, 2011 at 6:09 pm

        “For others (I would suggest at least Greece and Ireland) it very much is a case of solvency.”

        But isn’t their “insolvency” at least partly down to an inability to raise enough taxes – either voluntarily or involuntarily.


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