Duncan’s Economic Blog

Apocalypse Averted? Keeping Some Perspective on the Markets

Posted in Uncategorized by duncanseconomicblog on August 8, 2011

I learned quite a few things during four and half years working directly in financial markets, three of them are worth stating right now; the first causality of market turmoil is usually a sense of perspective, when market news is leading the main bulletins the story has probably moved on and, finally, markets rarely fall in a straight line.

In this spirit I thought it might be worth trying to provide some realistic and non-panglossian quick market commentary.

At the time of writing the markets are performing reasonably well, all things considered – the bond markets are behaving themselves; the equity market falls are limited. Apocalypse seems to have been averted, or at the very least postponed. That said, as we saw on Friday, markets can gyrate wildly during the day.

There’s a tendency, given the rapid availability of information, to assume that important market moves happen in hours and days – and sometimes they do – late 2008 being an excellent example.

But more often they move in weeks and months. The credit crunch began in August 2007 with the seizing up of the credit markets (although the first clues maybe came in June 2007 with the failure of two Bear Sterns hedge funds), Northern Rock failed in September 2007, central banks co-ordinated rate cuts in January 2008 as equity markets crashed, Bear Sterns failed in March 2008, worries developed throughout the summer of that year, Freddie May and Fannie Mac ran into serious problems in August and Lehman’s happened in September. The resulting market implosion bottomed out in March 2009.

It took a long time to play though and during that time there were many false dawns and (long-ish) periods of calm and market rallies.

 That all said, I also remember the February 2007 market panic after the Chinese index fell 10% and the May 2006 commodity-led correction – both of which were contained although felt worrying at the time.

The current market problems feel more like 2008 than 2007 or 2006 but we can’t be absolutely sure.

Despite all of the drama of the past week equity markets remain well above the level of a year ago, let alone above the Q1 2009 lows. This suggests that things aren’t quite as bad as the headlines imply – but also that any fall could go a lot further.

After the major falls last week, we should expect some sort of bounce. The usual pattern of a market fall is two steps down, one step up – not a straight descent.

Just looking at the Eurozone, the US and the UK– where exactly are we?

In Europe– the central problem of underperforming PIIGS economies unable to devalue remains unresolved. The ECB’s intervention today is having the desired effects of driving down yields on Spanish and Italian bonds. But it won’t stop the underlying rot of low growth and an explosive path of debt build-up and nor will it provide much relief from the effects of tough austerity which is strangling growth. More importantly, the real question is how long will it work for? How much money is the (still-divided) ECB prepared to commit to holding down PIIGS bond yields? We can expect the market to test this commitment in the coming days. In the medium term is a situation in which the ECB is the only real buyer of Spanish and Italian debt unsustainable?

In the US the major falls came before the downgrade.  A downgrade by one rating agency is unhelpful but not a disaster. US yields are still low. The real issue is not the debt burden but the faltering economy. The driver of the markets in the medium term will be the real economy.

In the UK the issue is similar – horribly low growth and the risk of a double-dip.

In the short term things look better today – but nothing is happening to resolve the fundamental problems of low growth.

6 Responses

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  1. Dave Holden said, on August 8, 2011 at 11:30 am

    I wonder what equities look like as measured against gold?

    And much as I agree with the sentiment on the effects of across the board austerity stimulus has hardly covered itself in glory recently see for example Mish’s recent post http://globaleconomicanalysis.blogspot.com/2011/08/decade-of-stimulus-yields-nothing-but.html.

  2. gastro george said, on August 8, 2011 at 12:49 pm

    Re your link, I’m tempted to say:

    “Ten years and $8.35 trillion later, what do we have to show for this decade of deficit spending?”

    Rich people who haven’t paid enough tax and two expensive wars.

  3. Dave Holden said, on August 8, 2011 at 1:09 pm

    I think you can add the expensive wars on to that list.

    It’s been clear all along the bail outs were about bailing out the bankers – the problem of course is “government” isn’t and probably never will be some idealised representation of the people it’s more often than not a representation of capital and power.

  4. jomiku said, on August 9, 2011 at 2:30 am

    This is not really the place to hash over economics – if only because I know people don’t listen – but Clinton left office with a surplus. I remember GWBush and the GOP – which then controlled Congress – saying this money belonged to the American people and that it should be returned as tax cuts. Those tax cuts put us in deficit. By the time they came up for renewal, the argument was that the economy needed them because it wasn’t doing well. We then had a record $480B budget deficit. The tax cuts were renewed by the still GOP controlled Congress. They also enacted Medicare D without any form of funding for it, but the effects of that are in projections of debt in the future much more than now or even in the near term.

    Bottom line is before the financial crisis, the debt had gone up by $5.6T, which means it doubled. Before the financial crisis. Of this $5.6T, about $1.6T is the literal cost of the tax cuts. Another big chunk is war spending, over $1T – the amount is in dispute with some claiming the cost is much more. Military spending has itself doubled. That amount is in dispute because it may or may not include all homeland security money and, of course, veterans’ affairs are actually handled through the non-defense discretionary part of the budget.

    Is this stimulus? Most of it wouldn’t be considered much of stimulus in Keynesian terms. It would under the GOP’s version of reality – and to conservative economic models. The so-called stimulus bill was actually 38% tax cuts – the largest in US history given their short duration and size. Military spending was a stimulus in WWII because it was really, really large. But overall, no one says that military spending is an effective stimulus; much of the money goes into big hardware and, other than salaries, it all goes to a relatively small number of companies. Yes, it stimulates areas where there are military bases and contractors but it doesn’t do much for the rest of the country. And much military spending is overseas.

    If you then go to the linked post, most of the items are somewhat nonsensical political verbiage. To say that we had $800B for “shovel ready” projects is a blunt lie. The cost of TANF has been negligible. All of the items from 8 on have little to do with the deficit. The housing credit programs haven’t been costly but they’ve been a bandaid on a truly gigantic problem caused by securitization & an actual aversion to regulation & enabling interest rates pushed by a libertarian Fed chairman.

    But more importantly, the arguments any economist who respects Keynes has made is that the actual stimulus was ridiculously small. And those arguments were made at the time, not after the fact. But again, when you get blunt lies about the stimulus bill tossed about, what do facts matter? Some stimulus programs worked. Cash for clunkers kept some hundreds of thousands to millions of Americans employed because that single act kept GM and Chrysler afloat – and to a lesser degree Ford. That worked. Chrysler was bought by Fiat and has been prospering. GM paid the US off and made $2.5B last quarter. Is the idea that cash for clunkers would have some magical effect that would transform everything? This is the kind of nonsense I hear: that it wasn’t a miracle in which a holy presence ordained prosperity. A lesser version is the nonsense that Keynesian stimulus requires some huge multiplier to be valid. It doesn’t. An example is the support of the states in the stimulus bill – and through supplemental unemployment authorizations. That money allowed the states to avoid contracting spending as fast. It helped keep them afloat. It wasn’t enough money to turn them around. A simple point: they were supporting state spending and thus demand when the recession was biting very hard. It’s truly stupid to argue that this was going to have some magical effect. But when people tell lies about the nature of the stimulus bill itself, I don’t expect more.

    So what I see is that the GOP wrecked the finances of the country and that people can’t accept that so they find ways to claim all this is failed stimulus. It’s a vast misunderstanding of Keynesian economics filtered through principles that people adhere to despite reality.

    The day I hear some of these people admit what’s now obvious: it’s over 2 years and despite massive amounts of money pumped into the system, interest rates are scraping 0 and now deflation again looks like a real chance. All those predictions pushed by conservative economists about inflation have not come true. And they’ve not come true for over 2 years, not just one month or six. Every prediction made by conservative economists has not come true. The only models that explain what has been happening now for over 2 years are Keynesian. So the response is to mischaracterize and tell lies. Brilliant.

  5. betweendays said, on August 9, 2011 at 8:32 am

    “markets rarely fall in a straight line”

    It looks like they’re falling in a straight line at the moment.

  6. James C. said, on August 13, 2011 at 10:48 am

    In the technologised world, “growth” means more energy consumption. The engineering of that’s a bit difficult at the moment.


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