Archive for July, 2012
During his inaugural address in 1933, President Franklin D. Roosevelt famously asserted that “the only thing we have to fear is fear itself.” Of the many comparisons which have been made with the Great Depression in recent years, this is one of the more tempting. Various catastrophes have been predicted; have failed, as yet, to emerge; and yet have damaged confidence to the point where the predictions have themselves produced an economic effect.
A good example of fear in action concerns the Indian rupee. Foreign exchange markets are wild beasts at the best of times, but the poor old rupee has taken a worse beating than most. Pretty much all the emerging market currencies were battered last summer – all the floating rate ones, at least – as US GDP was revised down, employment growth stalled and panic grew over a double dip recession. If this panic had proved correct (which it of course did not), this might have reflected a reasoning bet on reality: that developing world growth would turn to contraction on the back of contraction in major developed markets.
Then there was Europe. Fear over Spanish banks and Greek elections sent the rupee plunging further; having lost 18% of its value against the dollar over the second half of last year it fell another 5% during the first half of 2012. Soberingly, the Reserve Bank of India, which had been expected to cut its policy rate by 25bp last month, held it steady, citing concern over inflation – one consequence of a weaker currency.
A statistician revises GDP methodology in America, a coalition falls two seats short of a majority in Greece, and the effect is felt on monetary policy in India. The US did not have its double dip, Greece did not leave the eurozone, but the fear of both was enough for the job.
Of course, FDR’s statement was only arguably true when he made it. And today it would surely be only the most resolutely optimistic of politicians who would adopt “Happy Days Are Here Again” – or, perhaps, “Things Can Only Get Better” – as their campaign anthem.
Let’s take one more example. The $4.4bn accidental loss made on carefully calibrated, meticulously modelled and fully hedged derivatives trading announced today by JP Morgan (previously estimated at $2bn, then at $9bn) reminds us, if we needed reminding, that real bad news does crop up. That loss has led to a fall in the bank’s reported earnings per share of nearly 5% on the year at a time when Wall Street has already put on its bear suit again when it comes to the outlook for earnings.
And yet JP still reported falling loan writeoffs, an increase in mortgage lending as unemployment fell, and a resulting quarterly profit of $4.96bn. Without its derivatives turmoil – which it blames on its office in London, this month’s favoured destination for the financial scandal – it said that EPS would have risen by almost 50%. Now clearly this information tells us something just as material as the $4.4bn haemorrhage. But in a fearful world it is more often the ammunition for the bears that packs the bigger punch.
There was more to Roosevelt’s presidency than putting on a happy face, of course. Then, as now, policy action was by turns innovative, panicked, contentious, essential and disastrous. But his famous phrase has surely lasted because its neat paradox captured something true. It is not the only force at work, but the power of confidence on policy, markets, businesses and consumer behaviour is real.
That’s what it has felt like this week as monetary authorities all over the world have loosened policy. We have all seen how fear over Europe heightened again over the last few months; we know that fears over the US recovery and a Chinese slowdown remain; and of course as the IMF just reminded us, widely-followed economic forecasts that go up can also come down. Combine this gloomy background with the fact that the S&P GSCI commodity price index tumbled by 13% last quarter – taking what inflationary concern many central bankers had with it – and their desire to pour more punch into the bowl is understandable.
So China has cut rates again (and increased its banks’ flexibility to go further), the Bank of England has announced more quantitative easing, and the ECB has broken the 1% barrier. Now some of these moves were more unexpected than others. What has perhaps offered the greatest interest, however, has been the market reaction.
China’s historic changes of stance were taken to mean that Q2 growth, which is due for release next week, is going to be weaker than expected. The ECB’s cut wasn’t enough, failing to supply the magic bullet the market was hoping for. And in the UK, the widely expected increase in QE wasn’t good enough either. Stock markets which began the week with cautious moves upward have thought better of it, oil is down again today, safe haven bonds are up while corporate spreads and the eurozone periphery have suffered, and so on and so forth.
Some of the bear arguments over these policy moves are meritorious. This blog has long argued that QE is no more than a potentially hazardous distraction. It is quite possible that China’s motivation stems from more than just disquiet over Europe. And while a market which is looking for magic bullets in Europe is never going to find them – because there is, in real life, no such thing – a rate cut of 0.25% looks pretty modest.
And yet … Somehow the bearishness doesn’t seem to be hitting markets with the same naked terror that it did last autumn. When the Fed announced Operation Twist back in September, for instance – a smart monetary move insofar as it might have contributed to lower mortgage rates – the gloomy comments it made to justify its novel move saw the S&P 500 index fall by more than 6% over two days. New York hasn’t been open long today, but so far it has managed barely a quarter of that.
We have already looked at the argument that central bankers are “pushing on a string”, and noted that this is one of the more genuinely concerning bear points. But there is more to monetary policy than interest rates, and it is not just equity markets that have been worth following in recent months.
The euro suffered against the dollar on Thursday, falling by over a cent on the announcement of the rate cut. Trade weighted, it has (on Bank of England data) fallen by almost 2% so far this month; on the same measure it was 3.5% weaker over the second quarter of this year. With import price inflation having fallen for over a year now, it is likely that the ECB will be more grateful for this than fearful of it.
The same goes for China. Of course the renminbi exchange rate is managed, and the currency is not fully convertible – so its devaluation against the US dollar in May was an act of policy. Over Q2 the renminbi lost 0.9% of its value against the dollar: not a large amount, but noteworthy nonetheless as the first quarterly devaluation since the old currency peg was abandoned seven years ago.
While we may still see economic death in spite of a thousand cuts, then, it is not quite accurate to say that they are having no effect.