A chum of mine called me this week and asked what was happening to the markets. I replied, “They’re going down.” To which his response was, “Thanks. Now can I have the intellectual analysis please?”
But further comment, intellectual or otherwise, is superfluous. Investors worldwide are taking fright at significant downside risks they perceive on both sides of the Atlantic, aided and abetted by what they deem to be ineffectual and directionless policy-making from Western governments.
A G20 summit to discuss the problem may steady the ship for a short time, but won’t even paper over the cracks unless some firm action is taken to address the relevant issues. Some of this action will only take effect in the longer term, but it is possible to introduce more immediate measures as well. Ultimately, it is all about restoring confidence.
The sovereign debt problem in the euro zone is without doubt the biggest single factor pulling markets down. We’ve addressed this issue in this column many times, but after nearly two years of this crisis the European Union leadership is only at the cusp of a unified approach.
At the weekend it readied the market for Greek default, proposing a larger sovereign rescue fund facility and a plan to recapitalize banks. In theory, after the impending Greek default, this should prevent further contagion.
Unfortunately, it’s still only half-way there. It addresses the now — Greek sovereign bankruptcy — but not the tomorrow. The reason we are here in the first place is because the EU attempted to run a currency union without fiscal union, and, as predicted at the time, that has proved untenable. We have had no progress on this front, so investor nervousness will continue.
For the euro to be viewed as sustainable in its current form, genuine fiscal union is required, or else a change to its membership. The sooner one of these is agreed, the better, and given that the latter would be unimaginably painful for the global economy, it is the former that needs to be implemented.
It couldn’t be set up quickly of course, but an announcement that this solution had been agreed would at least calm the market.
But there are other measures that can and should be taken that would have a more instant impact and help restore confidence. First, the European Central Bank should reverse the two base rate rises it implemented earlier in the year, which were only weakly logical at best, and perhaps even cut the rate to below 1 percent.
The current rate is undoubtedly a drag on business activity in the southern euro zone, and right now inflation is the lesser of two evils (the greater being economic collapse).
It should also re-introduce the 1-year repo funding facility for banks that it withdrew last year, in order to reassure investors that banks will not suffer a liquidity crisis in the near term. A similar measure from the US Federal Reserve would go down rather well, too.
Second, governments needs to address the high level of unemployment in both the US and EU, through a range of measures that incentivize the private sector to take on more staff.
Measures aimed at unemployed youth would be particularly useful. These would not necessarily be Keynesian methods requiring further public expenditure—there are plenty of other measures that can be taken, particularly with respect to payroll taxes.
And third, countries need to address the fallout from the real-estate crash in the US, Spain, Ireland and elsewhere. This would require an element of government expenditure, as some measures—such as interest holidays for those in arrears—will need to be subsidized.
But it’s a more focused and targeted form of government expenditure than most, and the beneficial social impact of this would be considerable.
Of course, there are some important strategic issues that the G20 must address very soon: the tradeability of the Chinese yuan, setting up an alternative to the US dollar as the world reserve currency, an updated and more relevant role for the International Monetary Fund and the World Bank—but these will take even longer to address than any of the above.
So, one step at a time. Let’s pick the lower-hanging fruit first.
Dr Moorad Choudhry is Head of Business Treasury, Global Banking & Markets, Royal Bank of Scotland, and Visiting Professor at London Metropolitan University.