(1) It’s Not About the Downgrade
The New York Times’ Nate Silver poked holes in the S&P downgrade of U.S. credit, pointing out that Standard & Poor's doesn’t have a great track record on predicting financial risk. The firm didn’t downgrade Ireland’s AAA credit rating until March 2009, “long after” Ireland’s “financial problems had become obvious, and the price to buy insurance on its debt had increased tenfold from a year earlier.” That’s just one example of how “S&P ratings tend to lag, rather than lead, the market.”
Silver crunched the numbers and discovered that “simply looking at a country’s ratio of net debt to GDP” is “a better predictor of default” than the S&P formula, which “places very heavy emphasis on subjective views about a country’s political environment.” Those subjective views don’t always pan out.
At this point, the markets indicate that the U.S. is still a trustworthy investment: Silver points out that the interest rates on Treasury bonds and credit default swaps on U.S. debt are still extremely low.
“The downgrade, after all, was less about economics than politics,” agrees The New York Times’ Joe Nocera. ”In the end, a downgrade from a ratings agency shouldn’t keep anyone up at night; it’s a sideshow. What should cause some sleepless nights is the never-ending turmoil in Europe.”
These days, all economics is global. And the global outlook does not look good.
“The simple fact is that the global economy is falling back into recession or indeed is already in recession,” writes Societe Generale’s Albert Edwards, Financial Times reports. “U.S. GDP growth has now fallen below the well-known 2 percent stall speed.”
Between the threat of default within the Eurozone, stalled growth in the United States, and continuing unrest in oil-producing nations like Libya, there are more elements feeding stock market turmoil than just S&P’s analysis.
Perception that the U.S. government and the European Union leadership are too busy squabbling to agree on a course of action—let alone too timid to make the tough choices necessary to pursue a course of action—further undermines market confidence. Messy, systemic economic problems defy silver-bullet solutions, but surely our leaders could do something?
(2) Stimulus Is Just a Band-Aid
Jared Bernstein pushed for additional stimulus in his blog, dismissing inflation fears. The bigger issue, he writes, is that “interest rates are already low,” and “firms are highly profitable and sitting on trillions in cash reserves. So monetary policy faces a pushing-on-a-string problem.”
Nervous companies aren’t spending, nervous consumers—perhaps slammed by the fall in home prices, unemployment, or both—aren’t spending, and the Fed doesn’t have the political or financial leverage it needs to use government money to spur demand.
“Until last year policymakers could always produce a new rabbit from their hat to trigger asset reflation and economic recovery,” writes Nourel Roubini for Financial Times. “Zero policy rates, QE1, QE2, credit easing, fiscal stimulus, ring-fencing, liquidity provision to the tune of trillions of dollars, and bailing out banks and financial institutions—all have been tried. But now we have run out of rabbits to reveal.”
“In 2011, the financial world can't go cap-in-hand to the political capitals, hoping for a handout,” writes Francesco Guerrera in The Wall Street Journal. We don’t have a liquidity problem; we have “a chronic lack of confidence by financial actors” and government inability “to kick-start economic growth”—on both sides of the Atlantic. “In order to get out of the current impasse, markets will have to rely on their inner strength or wait for politicians to take radical measures.”
(3) Time for Some Fresh Ideas
The ideas President Obama has put on the table—like extending the payroll tax holiday and unemployment benefits, and investing in infrastructure—are a start, but not a solution, Nocera writes. “I know that there are limits to what any government can do to create jobs. But what one yearns for is a little imagination from this White House.” Why not start “a $50 billion fund for small business, and use it to pay, say, 20 percent of the wages of new hires for two years—first come, first served…?”
Let’s get technical and embrace “orderly debt restructuring,” Roubini writes. We need “across-the-board reduction on the mortgage debt for the roughly half of America’s households that are underwater, and bail-ins for creditors of banks in distress.” Struggling European economies need “Greek-style coercive maturity extensions, at risk-free rates.” Unless we address the underlying driver of the slowdown, we won’t get anywhere.
As for high unemployment in the United States, here’s the big problem, writes Financial Times’ Steven Rattner: “Our economy is buffeted by the relentless forces of global competition, that not only depress job totals but depress incomes.” That’s why we’re seeing layoffs in Detroit, and new manufacturing plants overseas or in right-to-work states that allow employers to pay their workers less.
Politicians need to “address the problem of faltering real wages,” Rattner argues—not by becoming protectionists, but by launching “major education and retraining initiatives, better incentives for starting businesses in industries where America can compete.”
Maybe we need to take another look at Wall Street, suggests The New York Times’ Floyd Norris. “An important lesson that leaders grasped in 2008 and 2009 was that free enterprise was not going to work without a decently functioning financial system,” and our ability to assess the solvency of big banks is as flawed as it was back in 2008. Norris pins the market turmoil on the July 20th stress tests of the European banks, which revealed that “Europe was still assuming that sovereign debts were risk-free.” Those assumptions were fundamentally flawed.
“The fact that billions of dollars in wealth are tied up in the judgments” of Standard & Poor's, “a company with such a poor record, is all the proof you should require that the global financial system is in need of reform,” Silver writes.
(4) Take a Deep Breath, and Take the Long View
“America’s share of the global economy has shrunk,” writes A.S. in The Economist’s Free Exchange Blog, but that doesn’t mean we should all panic. “If other countries get richer and America’s share of the pie gets smaller, that is not necessarily a problem. If the entire pie grows the actual size of America’s piece may increase.... You don’t have to be the biggest economy to grow and prosper. Britain was the dominant economy in the early 20th century, but it is definitely better to live in Britain today than in 1900.”
“Although your portfolio may have lost a lot of value over the past couple of weeks, you’re likely to get at least some of that money back (in fact, quite possibly most of it) because expectations for future returns have now improved,” Silver writes in a separate blog post. “Stock prices, especially in the United States, have had a reasonably strong tendency to revert to the mean.” Even though, “stocks may still be overvalued,” that “still implies a profit for long-run oriented investors.”
“In the long run, our best friend is time,” writes The Atlantic’s Derek Thompson. “In 10 of the 15 countries studied by economist Vincent Reinhart, unemployment did not decline to pre-crisis levels even a decade after the recession ended. As consumers build up their balance sheets, and new industries emerge and grow rapidly, the country will almost certainly return to full employment and steady, healthy growth eventually.”
Until then, however, we’re in for a bumpy ride.