Three crises prompt global stock market slide
The global stock market slide in the past week has focussed everybody's attention but it is really responding to three separate concerns: over the US recovery which is stalling; over the eurozone sovereign debt crisis, which is not over; and to slowing growth in Asia.
Of the three crises, it is the eurozone which remains the most critical. The deal two weeks ago to massively expand the European bailout fund known as EFSF, to soften the bailout terms for Greece, Portugal and Ireland and commit Europe to future fiscal union has not solved things.
First, because by pledging taxpayers' money from the European core to solve the problems of the periphery, it focussed attention on those countries within the European core who do not look very fiscally healthy.
Belgium, with no government and a bank - Dexia - heavily exposed to peripheral debt, and Italy which has a massive debt and is governed by a man whose competence has repeatedly been questioned.
Thus, in the short term analysts fear Italy maybe approaching the point where it can't borrow or where its borrowing costs become prohibitive. And while it does not stand in danger of imminent default, it becomes reliant on the European Central Bank (ECB) for liquidity - that is for short term purchases of its debt.
But the ECB is not yet prepared to buy Italian and Spanish debt, and the German Central Bank actually opposed the move to buy Portuguese and Irish debt on Thursday.
This, in turn, refocuses attention on the ECB itself. Alone among the central banks it is a currency without a direct tax base. Recapitalising the ECB would mean the countries of the European core stumping up tens of billions, on top of the hundreds of billions they have pledged to the new EFSF, and yet billions more from the European Union budget for a "Marshall Plan" for Greece.
'A form of current war'
The ECB cannot do what the US, UK and Japan have done - which is to print money to stimulate the economy and stabilise the banks, or it claims it cannot. In fact, the ECB has been engaged - for reasons to do with rules and personnel chosen in a different age - in the opposite: monetary tightening through a rise in interest rates.
The danger the markets are responding to is this: that the Brussels deal on sovereign debt and fiscal union falls apart. Hence calls from European Commission President Jose Manuel Barroso and ECB President Jean-Claude Trichet for the swift honouring of commitments.
The US component of the crisis is different. It is clear that the President Barack Obama fiscal stimulus has failed to kick start self sustaining growth and job creation. The monetary stimulus - QE and QEII - has worked to an extent. But at a price of exporting inflation to the developing world and flattening Japan's recovery (because monetary stimulus, leading to a fall in the value of your currency, is - as the Brazilian Finance Minister Guido Mantega pointed out - a form of currency war).
However, Congress just voted to end the fiscal stimulus. Indeed, the US is now committed to a 10 year shrinkage of state spending by $2.4tn. If you believe what is causing the US' stagnant recovery is the size of the state and its debt (and many economists do) then the Obama-Boehner deal done on Sunday night is good news.
A second credit crunch?
However, many economists do not believe that. They believe in fact the US economy was so busted by the banking crisis of 2008 that only a further monetary and fiscal stimulus will revive it.
Time will prove one side or other right. However, in the short term, America's capacity to borrow at rock bottom rates is being damaged by the perception that its political class is incompetent. As the satirical Onion magazine put it Congress Debates Whether Countries Should Be Economically Ruined.
They did it once, they can do it again. Technically, given the warnings from ratings agency S&P, the US stands in danger of a downgrade even despite the deal.
Now what do these combined pressures on the US Treasury, the ECB, Italian and Belgian debt tell us?
That - as I have written here before - when we decided that the state should save freemarket capitalism without anybody taking a serious loss, we simply transferred the losses to the state itself. And some states were not strong enough to bear the loss. And not just states, but interstate arrangements got busted in the process, above all the eurozone.
What next? It is actually quite difficult to achieve a double dip recession, technically. The US managed it in 1937 through summary withdrawal of stimulus. So what still looks on the cards is a petering out of recovery in the US, and a localisation/retreat of recovery in the EU (to the northern core).
What could complicate this is if, on the back of sovereign debt worries, we get a second credit crunch emanating from banks exposed to distressed countries, or a second credit squeeze (as per August 2007) when the interbank lending markets suddenly became tight.
In the process, everybody will be tempted to play "beggar thy neighbour". The US with a third round of QE, aimed at - whatever they say in public - a lower dollar; Japan has already responded to a flight to the Yen by intervening to reduce the Yen's value on global markets and doing more QE yesterday. China's policy is one big act of currency manipulation with the same ends. Which leaves…
Europe, whose central bank is losing credibility, needs capital; and yet whose currency will appreciate as the others resort to currency competition.
In a world where - as they say on the bond markets - "all risk is political risk" the main political risk lies in Europe. And the risk remains that it cannot contain the crisis it thought it had contained just two weeks ago.
This is what the transparent part of the global equities market is doing: de-risking in the face of US and EU uncertainty and slowdown.
But, of course, there is the hidden part. The hedge funds that are reportedly selling gold to cover losses elsewhere, having taken bets that didn't come off. You would need to know more about this to gauge whether the hedge fund losses have any macro-economic impact (beyond wiping out the money of some rich people)
I should conclude by saying I am writing this on holiday, by popular demand from my Twitter cronies. If you see me suddenly on your TV screen, sporting a tan, stubble and a t-shirt proclaiming the virtues of Ouzo you may conclude things have got really serious.