January has not been much fun so far in world stock markets. The bulls have seemed to be in hiding from the first trading day of the year, and lately panic has broken out. Could it be the bulls are feeling as glum as Merrill Lynch, the mega-broker that uses bulls for a logo? Merrill’s write-downs this month are enough to make any bull hang his horns in shame.
Until recently, bank and related stocks were sharply down but investors’ money had poured across to other sectors of the stock markets. Now investors seems resigned to the prospect of some sort of economic slowdown, in the US at least, and share prices are beginning to reflect the belief that corporate profits across all sectors will fall in that environment.
Wall Street tried bad-mouthing the chairman of the Federal Reserve, Ben Bernanke, presumably in hopes of stampeding him into a steep new emergency interest rate cut before the regularly scheduled Fed Open Market committee meeting at the end of January. He’s an academic, they howled to the media. He doesn’t understand markets, they sneered. A real Fed chairman would not ask politicians for help from fiscal stimulus, they jeered.
No dice at first. Bernanke told Congress the Fed stands ready to do whatever it takes, and then he stood pat. But with the worldwide selling frenzy on Monday, Bernanke blinked and the markets got their emergency cut a week early.
Well, if the pundits on Wall Street – who created the financial shambles in which they now find themselves – had had any residual insight, they might have recalled that Fed chairmen should not act when hucksters are yelling that they must act. Responding to the self-seeking pressure of bankers and brokers who have messed up is a surefire way for the Fed to lose all credibility, especially on price stability. Responding to a market panic that batters stock values – as the Fed did on Tuesday – is not quite as bad as giving in to a lot of critical talk, but it does not inspire much confidence, either. It also leaves the Fed with less room for manoeuvre in the near future.
The Fed is supposed to manage monetary policy in order to foster economic growth without accelerating inflation. Just because, for the past decade or so, following that line has also made huge profits for Wall Streeters does not mean rescuing the stock market or reducing cost of goods for imprudent lenders have become parts of Bernanke’s job description. The only reputable excuse for responding to a stock market panic is that it affects the real economy: with their portfolios hurting, households will cut spending.
The reality is throwing cheap money around to address the current economic situation has a couple of limits. First, inflation becomes a concern if money supply expands very fast and, second, low rates may not help to swell loan volume and spending if bankers are already feeling leery about over-extended borrowers defaulting. Fiscal stimulus may be just as inflationary as cheap money, but, if done right, it will get spending and activity going where lenders and borrowers are holding back. Rates almost certainly will be slashed at the end of the month and again at the next Fed meeting, but there’s always a lag and these moves will not fend off a consumer downturn in the next couple of quarters if one is on the cards.
The latest political mutterings are that Congress will finalise a fiscal package of tax rebates and suchlike by March 1. Why not by tomorrow? Speedy stimulus is the only fiscal stimulus worth having. The President has come around to the realisation that stimulus is required, so he’s not the obstacle. Also, the available ways of providing a fiscal boost are well known.
The sad truth most likely is that, before they finalise the deal, leading legislators need time to shake campaign contributions out of the various special interest lobbyists who seek to influence them on the details.
The economy can just wait for business as usual inside the Washington DC beltway.
Non-housing forms of consumer finance have been the shoes that the pessimists (or realists?) had been fearing would drop next on the US economy. If a growing number of households are not keeping up with their credit card or car payments, they are in distress. Banks will probably have to tighten lending to these people and to others who look like them, and this segment of debt-laden consumers will not be able to borrow and spend as they have in the past few years, until they have put their finances back in order. That subtracts another chunk of demand from the US equation, along side of the drastic reduction in housing activity.
More than housing, this kind of retail consumption cut applies heavily to goods that are imported into the US. That is why the Chinese are taking notice. As Zhang Tao, one of China’s central bankers, told a forum this month: “If US consumption really comes down, that’s bad news for us. That will have a pretty severe impact on our exports.” Chinese commentators fear Europe’s economy depends on the US consumer, too, but that is less obviously the case.
Both Asia and Europe will need to boost their own consumption to compensate for the missing American spender of last resort. That was going to have to happen sooner or later, because the US could not indefinitely run a trade deficit of seven per cent of gross domestic product. Nor could American households take on ever-increasing debt while their incomes stagnated, despite what bundlers of sub-prime debt may have told their customers. It looks as if that adjustment time may have arrived. If so, the big new question will become whether policymakers (and consumers) in Europe and Asia are nimble enough to transition to higher consumption and less dependency on US exports.
Just how much of a disruption the global economy could face does depend very much on how bumpy the US economy gets. We know that we have only begun to see the interest rate re-sets on those sub-prime mortgages. If 2008 brings a massive wave of re-sets, defaults and foreclosures on homes, it’s hard to imagine avoiding the 25 per cent drop in house prices foreseen by the likes of former Treasury Secretary Larry Summers.
Wave goodbye to all the consumption Americans financed in recent years with home-equity loans. Their home equity would be wiped out. There could be a wrenching drop in consumer spending, with a vicious spiral of job layoffs as consumer businesses cut back, too.
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