Welcome to the new normal. Billions of dollars were wiped off the value of shares in London on Tuesday. Dexia, a bank jointly owned by the French and the Belgians, teetered on the brink of collapse. One of the main barometers of Wall Street sentiment slid into bear-market territory. An emergency press conference called by Greece’s finance minister was delayed because the building was being picketed by civil servants.
The UK construction sector looked like it was heading for recession as public sector projects dry up and in Spain more than one in five are out of work. The French and Belgian governments were forced to pledge that no depositor in Dexia would lose a cent let alone a euro as they tried to avoid a run on the bank. Traders, unsurprisingly, were scrabbling for their tin hats.
The turmoil overshadowed the UK Conservative party conference this week just as it did three years ago when the shock waves from the collapse of Lehman Brothers diverted attention from the then-party leader (now British prime minister) David Cameron’s attempts to portray himself as a prime minister in waiting. UK coalition government ministers know now, as the then-British prime minister Gordon Brown and his team knew then, that the global economy is teetering on the brink of recession.
Jean Claude-Trichet, in his last few days as president of the European Central Bank (ECB), said on Tuesday: “We are experiencing the worst crisis since World War II.”
US Federal Reserve Chairman Ben Bernanke said the bank would do whatever it takes to get the US economy moving again. His comments helped lighten the mood on Wall Street and limit the fall in London’s FTSE 100 to 131 points.
Even so, the FTSE closed below 5,000 for the first time since July last year.
For those who believe that history repeats itself, Dexia plays the role of Bear Stearns in this unfolding tragedy. The US government found a buyer for the Bear in the spring of 2008, but failed to do the same for Lehmans six months later. Dexia will be saved courtesy of French and Belgian taxpayers. Next up is Greece, and there the endgame is now inevitably going to be default.
The panic-stricken reaction of the markets over the past few days reflects a growing mood in the financial markets that the default will not be managed and orderly but messy, with knock-on effects not just for the rest of the eurozone but for the entire world economy.
Banks will go bust, credit will dry up, trade will wither, jobs will be shed. Greece, Lehman Brothers 2.0, will be the prelude to the second Great Depression, something policymakers were congratulating themselves on avoiding only a few months ago.
The fear in finance ministries, central banks and the world’s bourses is that perhaps the bullet was not dodged after all. That is still a minority view. Despite the hamfisted way in which Europe’s policy elite has mishandled the Greek crisis — a mixture of dither and daftness — there is still a residual belief that something will be done to prevent a domino effect from a Greek default.
“I can’t believe that the German finance minister doesn’t have a file in a top drawer somewhere marked ‘plan B,’ which will be activated in the event of a Greek default,” said Nick Parsons, head of strategy at National Australia Bank in London.
Such a plan would involve allowing Greece to renege on 50 percent of its debts, already unaffordable and growing bigger by the day. Banks across Europe would suffer losses as a result, but governments would find ways of injecting more capital into any struggling financial institution, even if that meant full-scale nationalization. The ECB would step in to buy Italian and Spanish bonds in large quantities to prevent the contagion spreading.
This, though, suggests that European policymakers are in control of events. The financial markets are far from sure that they are.
“Politicians are two months behind reality, and their lack of clear leadership in the eurozone is spooking the markets. Investors can’t see any reason to rush into investments at the moment and they are not being soothed by patchy announcements which offer words not actions,” said David Miller, partner at Cheviot Asset Management.
Hence the concern about the alternative, much darker scenario in which the financial market pressure on Greece becomes intolerable and triggers a default for which the politicians are not prepared.
Market interest rates for the other struggling eurozone countries go through the roof. Banks in the US refuse to extend lines of credit to Europe, where the banks go down like ninepins. Greece decides that the only long-term solution to its problems is to leave the euro, thus triggering a rapid unravelling of monetary union. As in the 1930s, deep economic distress has profound political consequences, fostering the growth of extreme nationalist parties.
This is the doomsday option, and over the coming weeks and months finance ministers and central bank governors will do all in their power to prevent it from coming to pass. They will turn on the electronic printing presses, they will allow budget deficits to rise as growth slows, they will cut interest rates where it is possible to do so.
Should the worst case (or anything approaching it) come to pass, recriminations will fly thick and fast. Trichet will be blamed for banging up interest rates in the eurozone when Greece, Portugal and Ireland were in recession. German Chancellor Angela Merkel will get it in the neck for Berlin’s hardline approach to bailouts. European Commission President Jose Manuel Barroso will be accused of bowing to IMF demands for punitive terms for financial assistance, thereby putting the whole euro project in jeopardy.
There is something in these accusations. It is now the best part of two years since the Greek debt crisis began, two years in which the problem was denied, ignored and downplayed.
Everything that Europe has done since Greek Prime Minister George Papandreou admitted that the previous government in Athens had been cooking the fiscal books has been characterized by four words: too little, too late.
But this is not the whole story. Europe’s public debt crisis is the sequel to the private debt crisis that broke in the summer of 2007. Governments amassed huge budget deficits in an attempt to shield their economies from the worst effects of the collapse of the borrowing bubble that inflated in the first half of the last decade.
The roots of that go back still further, to the increasingly dominant role of big finance in western economies over the past quarter of a century. The story has been of banks free to lend what they want and a private sector free to borrow what it wants. Mini financial crises, in Mexico, in Southeast Asia, in Russia, in Brazil and Argentina, were dismissed as inconsequential, until in 2007 the bug burrowed its way to the very heart of the global financial system.
So what happens now? Some things are not in doubt. It will be a tough winter. Greece will default at some point. Policy will respond to economic weakness, but answers to the bigger questions remain unclear.
Will the euro survive? Will there be a second banking meltdown? Is the world facing a decade or two of sluggish growth to match the Great Depression of 1873 to 1896, as some historians believe. Nobody really knows. Which is why the new normal is not really normal at all.
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