Monthly Archives: July 2011

According to the GDP statistics released on Friday, the US economy has grown at less than 1 per cent annualised in 2011 Q1 and Q2 combined, a rate which is well below its usual stall speed. This is very sharply lower than I expected at the start of the year. Previously, economists were puzzled by the “jobless recovery” in the past few months. Now the mystery has been solved: there was never much of a recovery in the first place. And the solution to the debt ceiling crisis which may emerge in coming days will, in all likelihood, do nothing to help matters. 

Read Gavyn’s piece on the FT’s A-List site:

The latest figures show that Britain’s economy grew by only 0.2 per cent in the second quarter, which the Office for National Statistics says was equivalent to 0.7 per cent after taking account of the extra bank holiday for the royal wedding, and the effects of the Japanese earthquake. One excuse after another! Taking a slightly longer view, the economy has barely grown at all, according to the official statisticians, over the past three quarters. What should be done about this?

 

With the global economy uneasily poised between growth and stagnation, there is more than usual interest in the twists and turns of monthly activity data at present. In the next two or three months, we should discover whether the slowdown recorded in the first half of the year was just a temporary phase, triggered by the natural disaster in Japan and the passing impact of higher oil prices, or whether the debt burden in the developed economies is taking a more serious toll on growth prospects.

Most macro-economic forecasters continue to take the more optimistic view, and this is probably still justified. But doubts are creeping in with every month of weak data, and the early read on July from the data published last week has once again been worrying. 

The European summit on Thursday has resulted in a belated, but still impressive, step towards a resolution of the sovereign debt crisis. The measures were clearly more significant than the markets expected, but at the same time they have fallen short of a once-and-for-all resolution of Europe’s debt problem. Several key compromises have been made, notably between the German government and the European Central  Bank, and these have removed some previously immovable obstacles to progress.

The institutional plumbing is therefore now in place to resolve the crisis completely. But this still leaves one crucial question: how much money will be sent down the pipes? On that, the summit offered no new guidance. 

Update: Read Gavyn’s comment on the likely outcome of the emergency summit in Brussels.

Ever since Italy was sucked in to the European debt crisis a couple of weeks ago, commentators have warned that there has been a profound transformation in the nature of the crisis, which requires an equally profound change in the political response from Europe’s leaders. Ahead of tomorrow’s European summit, no such response appears to be forthcoming.

By all accounts, the summit will focus primarily on Greece. In addition to new loans, we should see some genuine debt relief for Greece, finally attacking the solvency issue, and not just the liquidity problem. With luck that might remove Greece from the limelight for some time. Eventually, similar programmes will become inevitable for both Ireland and Portugal. But it is still far from clear whether any of these countries will be able to implement the fiscal tightening they are promising. And the wider systemic issues which are now plaguing the eurozone will be left completely unresolved. 

Martin Wolf said to me last week: “I am off for a holiday. By the time I return, two G7 governments may have defaulted on their debt.” I think he was only joking, but the past week has certainly been dominated by fears of sovereign debt defaults, with the US and Italy now in the front line.

They are two very different kettles of fish. The US problems, at least in the near term, are largely self-inflicted as a result of the game of chicken being played by politicians in Washington. In Italy, on the other hand, the perceived risk of default stems from the fundamental problems which the economy is facing as a result its own “lost decade” of growth, exacerbated by the failure of the Eurozone to solve its peripheral debt crisis. Italy’s problems seem much more intractable than those in the US. 

Ben Bernanke

Ben Bernanke. Image by EPA.

The financial markets seem determined to interpret today’s statement by the Fed chairman in a dovish light, but a careful reading of his words does not support that point of view. True, Mr Bernanke outlined the possible ways in which monetary policy might be eased further if recent economic weakness should prove more persistent than expected. But he gave equal weight to the possibility that “the economy could evolve in a way that would warrant less-accommodative policy”.

There was no hint in the text about which of these outcomes he considered the more likely. We already knew from yesterday’s FOMC minutes for the June meeting that the committee is split about the likely evolution of policy, and we were waiting to see today whether the chairman would throw his weight behind either the doves or the hawks. He failed to do either. 

Risk assets like global equities have had a very bad day, but they are still trading fairly close to their highs for the year. This is surprising, given the continuing slowdown in the global economy, and the failure of policy makers in Europe and the US to come to terms with the serious problems facing them.

Particularly worrying is the growing evidence that the US economy is struggling even to hold unemployment constant, while fiscal and monetary policy have both become moribund for the time being. The markets still seem confident that US growth will spontaneously reignite in coming months, without requiring any help from expansionary policy. If they are wrong, there are few signs that US policy would be able to respond quickly or coherently. 

Under normal circumstances, the decision of the ECB to raise interest rates by 0.25 per cent at a time when the European economy is slowing, and inflation seems to be peaking, would have been a very big deal. However, with the peripheral debt crisis still deteriorating, the rate increase has not really been the centrepiece of market attention today.

Instead, the main focus is on the composition of the ECB’s balance sheet, where a much larger, if slower moving, story is unfolding. The ECB is gradually being drawn into the “socialisation” of peripheral country debt, in ways which are completely outside the control of the central bank, and which could yet end in crisis.

Today, the ECB decided to continue accepting Portuguese debt as collateral for repo operations, even though Portugal has been downgraded by Moody’s this week. The ECB is increasingly taking actions which they would have deemed unthinkable two years ago. But they are trapped, and will remain trapped until there is a more comprehensive solution to the peripheral debt crisis. 

The ongoing discussions in Washington about the US public debt ceiling are raising some interesting ideas, some of which are highly unorthodox. One such idea is that the debt ceiling itself can simply be ignored because any attempt by Congress to restrict the ability of the United States to meet its debts appears, on the surface, to contravene section four of Amendment XIV of the Constitution.

This Amendment states that “The validity of the public debt…shall not be questioned.” I will leave this matter for debate among constitutional lawyers (see here and here), but as a simple economist I would question whether the US would retain its triple A status if the administration continued to make payments in contravention of an explicit act of Congress, which the President believed to be unconstitutional. What would happen to the “full faith and credit” of the United States if the Supreme Court subsequently ruled that the President was wrong?