Economics Views : 1 Dec

December 3, 2010

What makes people think what they think
is a mystery.

Psychologists claim to understand the causality. But, demonstrably, they don’t.

Stock markets grind data very slowly.
Investor psychology is sometimes enlightened and sometimes perverse. But it’s always difficult to manage. Those who try to do so rarely succeed; usually, they make matters worse.

But exceedingly finely.
The banking crisis demonstrates the phenomenon. Two years ago, it was thought to be a largely Anglo-Saxon problem. Bureaucrats at the Commission in Brussels and Central Bankers at the ECB in Frankfurt oozed Schadenfreude.

And the longer they take, the more robust the conclusion they reach.
The reality was otherwise. Irresponsible banking hadn’t been confined to the US and the UK. It’d been rife in much of Europe as well. But, while countries in the one group were quick to acknowledge their misbehaviour, those in the other had tried to hide it.

The European banking crisis is a case in point.
Only slowly did the truth emerge and only slowly therefore did investor sentiment deteriorate. But, once started, the process proved irreversible. Investors distrusted official statements. If a Minister or Central Banker declared his banking system to be safe, he didn’t calm the market’s anxieties, but inflame them!

Investors were initially dismissive.
The issue became one, not just of local banks, but of the future of the single currency. Investors wanted to know how a country choosing to leave the EMS would treat its euro-denominated debt. Would it be honoured or repudiated? The question was posed, but not answered.

But are now obsessive.
Understandably nervous, investors avoided the debt of suspect countries. That caused their bond yields to rise, and the higher they went the greater became the risk of systemic default. Banks and Governments might have been able to survive “normal” interest rate premiums, but not these “abnormal” ones. Disaster was assured.

Yield differentials make it clear they expect disaster.
Today, only Germany and its close acolytes (the Netherlands and Austria) are trusted. Only they are able to raise money in the bond markets. If the EMS is to survive, therefore, if the EU itself is to have a future, it’ll be necessary, at least temporarily, for the strong to guarantee the borrowings of the weak.

If the EuroZone is to survive, . . .
Will the former be prepared to do so? Not unless they also take charge of the latter’s financial affairs: the control of their budgets and the regulation of their banks. Goodbye, in that event, to democracy.

. . . Germany’ll have to provide blanket guarantees.
Does the Commission or the ECB have anything insightful to say about these matters? Of course not. Neither knows how to deal with the markets. Both nevertheless spout nonsense. Trichet claims that the single currency is fundamentally “sound;” Barroso, that it’s been a great “success.” Hmph.

The UK could have escaped; but it hasn’t.
Britain, sadly, isn’t free from the sickness. She’s wasted one fortune trying to save her own failed banks, and now she’s busy wasting a second trying to save Europe’s. There might have been a change of Government, but there’s been no change of policies.

Amongst the old brigade, the US and Japan are best placed.
The good news is that the non-European developed economies have been performing fairly well. In the middle quarters of 2010, the US, the UK and Japan produced a conjunction of growth, inflation and external deficit that verged on the satisfactory. It’ll probably not last. Activity will slow during 2011. But, for those operating sensibly, it’s possible to hope that the retrenchment will be modest.


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