Impotent global institutions make 'grand bargain' elusive
- Economic problems largely unsolved – especially in the Eurozone.
- Global institutions are too weak or too political to force a grand bargain
- Things will have to get much worse before they can get better
The consensus view seems to be that the response to the financial crisis is reaching its limits. While the US has recovered relatively well, China is still trying to come to grips with the deleveraging and rebalancing it must face, and the Eurozone has not even properly started.
Euro area dragging its feet
Europe’s banks are still undercapitalised, bank lending is not growing, structural unemployment remains high, and the very slow and erroneous response to the financial crisis and inability to respond to the refugee crisis suggest the European Union is not getting its act together any time soon.
While monetary policy has been used in unprecedented doses and scopes, it has not been enough to remedy the problems – more action is required. It is a sorry state of things that it seems more plausible that the US will save the world with QE4 and an increased supply of US dollars rather than that the euro area would finally tackle its problems.
If the “reaction function” of European decision-makers is weak – meaning that things will have to get really bad before even limited action is taken – it does not suggest happy times. Even if other major regions were to do their part, it would probably end up being just an excuse for Europe to not do its own part.
Potent global institutions missing
Even if the EU were to get its act together and be able and willing to do whatever it really takes, the international nature of the underlying problems stops it from reaching a solution. We’ve already seen how lack of global coordination makes regional action less effective. The international institutions are not up to the task. The United Nations is largely a joke, and the World Bank and OECD are too weak.
The International Monetary Fund is the only global player with enough knowhow, size, scope and access to political power to make something happen. Unfortunately, the IMF suffers from political capture – probably precisely because it is an important and powerful organisation. The IMF didn’t do well in the euro crisis, and it has shown no signs of willingness to step up its game. Perhaps it is still feeling sorry and shameful, and trying to keep quiet so that it wouldn’t face a total clean-up.
Random get-togethers ineffective
Other global gatherings are not any better. While the IMF urged this weekend’s meeting of Group of Twenty countries’ central bankers and finance ministers to keep monetary policy easy, ease fiscal policy, introduce supply-side reforms and better coordinate the international policy response, it is clear that no such thing is happening. Germany’s finance minister announced even before the G-20 meeting had started that his country opposes fiscal stimulus.
Saxo Bank's FX strategy chief John J Hardy said it beautifully today: “Austerity is not the answer. Germany’s stance on fiscal stimulus must be crushed and reversed if the EU is to have any longer term viability.”
During the crisis years, I don’t remember any G-[insert random number here] meeting doing or saying anything remotely constructive.
The problem is that even a good get-together and a relatively strong consensus is killed when one or two strong participants have opposing views. The world economy should not be held hostage to the German Christian Democratic Union’s poll performance or the narrow interest of German regional savings banks.
This suggests there are two stable solutions to the current malaise: either things must get so bad that Germany caves in, or, alternatively, an international meeting must be held that doesn’t require unanimous support for its delivery of a solution.
Solution #1: Germany caves in
Germany’s political stance will shift when the politically powerful banks and export industry say enough is enough. That would require a deeper crisis than we’ve seen so far. Deutsche Bank getting close to being thrown under the bus or large German exporters facing declining profits would be it.
Another possibility is that the costs of the refugee crisis become so big that fiscal spending must be increased, which, while not productivity-enhancing, would be at least a short-term stimulus . It would also be the first and not the last exception that would break the ill-conceived stability pacts that now constrain economic policy.
Solution #2: Powerful international conference
The most important central banks could meet and act together, by first recognising that, at the limit, monetary and fiscal policy are the same thing. By increasing asset purchases, not only in size but also in scope, the central banks could easily circumvent bans on monetary financing. At the end of the road, purchases of corporate bonds, uncovered bank bonds, directly funding citizens and corporations loom. And when that decision is voted on by the European Central Bank’s governing council, Germany has only one vote. Schauble’s “Nein” would be moot.
Markets may be too optimistic
Financial assets are clearly trying to second-guess when and how the ECB and the Fed will "cave in" to the bad situation. For the moment, bad news are good news, as the tipping point comes closer, but the markets might be underestimating the resilience of the "Neins" and the slowness of the potential get-together. The ECB's reaction speed is very, very slow, and also the Fed seems to be stuck in its "rate hikes at the market top" action plan.
See also my earlier piece “Is the ECB doomed to disappoint?”