Hope springs eternal in the markets — until it evaporates like dew before the hot sun (lots of that in northern VA, by the way). There is so much cash sitting on the sidelines, or earning near-zero interest in bonds, that traders and investors would love to move into equities and go back to living in a world of 7-8% annual gains. So every time there is a hint of any policy or data that suggests a return to normalcy, investors pour into equities. That’s the only way to explain the huge market run up earlier in the week in response to the tepid half-measures of the Euro Summit, promising (but not actually implementing or delivering) a method for Spanish banks (but not the Spanish, Italian, or Greek governments) to escape insolvency by receiving fresh funds from the European Stabilization Mechanism.
As with past measures, the half-life of optimism is measured in hours or days; as Spanish 10 year bond yields are once again above the long-term death spiral rate of 7 percent — which the whole point of the summit was to avoid. The European Central Bank did lower its interest rate by one-quarter of a point to 0.75 percent. (But what are they waiting for? Armageddon? Why not lower it by a half-point or three quarters? Bund yields are already negative, as are inflation-adjusted US treasury yields. The US Fed has promised to keep short-term rates at effectively 0. Why on earth should the ECB still have rates at a positive 0.75 percent??) However, the rate cut was overshadowed by ECB’s announcement that they would not led directly to the European Stabilization Mechanism or other Euro bailout funds; thus those funds would have to raise money directly from EU taxpayers or other lenders — which seem about as likely as the money dropping in from Mars.
In other words, the EU policies are so far just a fizzle. And with that now evident, the markets have resumed their downward slide.
For in the real world, it is increasingly evident that determined austerity policies in Europe are dragging the whole global economy down into an ever-deeper recession. Here is some of the latest news — UK in recession; China manufacturing declining for several months in succession; US manufacturing showing the biggest decline since 2008; growth in India and Brazil down sharply. Growth prospects in Germany looking gloomy as well. US corporations showed the first quarter-on-quarter decline in profits since 2008 for 2012 Q1, entirely due to falling profits oversears. Commodity prices are sliding fast, and US employment remains stuck at deep recession levels, with job creation slumping.
Why is this all happening? It’s really quite simple — after the credit collapse of 2008, the world entered a deleveraging phase, compounded by slow-downs in labor force growth in the rich world, further aggravated by a collapse in household wealth and a long stagnation in wages driven by several decades of increasing income inequalty. Add it all up and it means there is no growth in demand, hence no reason for companies to hire and invest. A classic 1930s textbook scenario, it’s easy to recognize today (I learned about the deflationary spiral and its effect on unemployment in the 1970s in college, well before the ‘great moderation’ and the shift in economic theory denying that the Great Depression could have ever existed except for foolish irrational mistakes.) So the policies to fight this problem are known as well — do everything you can to increase demand and hiring. But what are the leading economies doing? Exactly the opposite — they are cutting workers in the public sector, and raising taxes which lowers demand. Banks are being told to increase their credit-worthiness and reduce risk, so they are hoarding capital, which further lowers demand.
This is because no one believes classic economic theory any more — the economists who told us another depression could never happen are obviously wrong, but they still insist that the economists who are advocating Keynesian solutions are wrong too. So all that policy-makers can do is listen to businesspeople and moralists, who tell them you have to watch the bottom line, get governments out of debt, and raise taxes on workers but lower them on business and the rich. But this policy does absolutely nothing to raise overall demand, since governments have to borrow to hire more folks or pay raises, taxes on workers mean they spend less, and tax cuts on business and the rich let them keep more money, but they don’t spend more (they already buy everything they need). Instead, they invest–driving down bond returns and driving up property prices and asset prices in privileged markets.
This nonsense is likely to prevail another few years, at which point it will finally become obvious to everyone that Hoover-style pro-business austerity measures have been a dismal and self-defeating failure. At that point (2014, 2015?) we may finally move toward the progressive measures that may slowly lead us out of the woods, although by then the damage (a generation of lost young workers, the dismantling of the Euro, a huge loss in wealth) will have been done.