MARKETS ARE REACTING TO CRISIS OF CAPITALISM / THE FINANCIAL TIMES MARKETS INSIGHT ( A MUST READ )

Markets Insight

September 12, 2011 10:56 am 


Markets are reacting to crisis of capitalism

By George Magnus


Financial markets have had a torrid summer of breaking news about slowing global growth, fears over a new western economic contraction and the unresolved bond market and banking crisis in the eurozone.


But these sources of angst have triggered turbulence before, and will continue to do so. Our economic predicament is not a temporary or traditional condition.


Put simply, the economic model that drove the long boom from the 1980s to 2008, has broken down.


Considering the scale of the bust, and the system malfunctions in advanced economies that have been exposed, I would argue that the 2008/09 financial crisis has bequeathed a once-in-a-generation crisis of capitalism, the footprints of which can be found in widespread challenges to the political order, and not just in developed economies.


Markets may actually have twigged this, with equity indices volatile but unable to attain pre-crisis peaks, and bond markets turning very Japanese. But it is not fashionable to say so, not least in policy circles.


Recognition would be a good start and it was refreshing that the new head of the International Monetary Fund, Christine Lagarde, recently called for co-ordinated macro policies to support economic growth and the mandatory and substantial recapitalisation of European banks. But this clarion call is not being heeded.


It is a crisis of capitalism because our economic model and policy settings cannot produce sustainable growth, adequate income formation or employment creation. We have lost the housing, financial services and credit creation growth drivers and been left with excessive levels of personal and government debt to unwind, a dysfunctional financial system, and weak labour markets.


The capacity to produce and sell goods and services has outstripped that of consumers to borrow and spend. Without credit and jobs, other fault lines have been exposed, including the long stagnation of real wages and extremes of inequality. It is truly a crisis of aggregate demand.


The latest US employment data, for example, showed that the level of employment in the US is no higher than it was in 2004. The proportion of the population aged over 16 in work is the same as in the 1950s.


Nominal gross domestic product is stagnant and levels of real GDP and personal income (excluding government transfers) have stalled just below their peaks in early 2008. New housing construction and automobile sales are 75 per cent and 30 per cent, respectively, below their 2006 peaks.


What to do? With governments embracing austerity, voluntarily or under the IMF, and with seemingly irreconcilable divisions over policy in the eurozone, the focus has returned to monetary policy – the one straw at which markets can clutch.


The European Central Bank is committed to backstopping the Italian and Spanish bond markets, the UK Monetary Policy Committee may be shifting towards another round of quantitative easing (QE) and currency interventions by the Swiss and Japanese central banks are just printing money by another name.


Now, after the US employment figures, the Federal Reserve will most likely announce new measures following the September FOMC meeting. These could include asset purchases and operations to lower long term bond yields relative to short-dated securities.


While these forms of QE can liquefy financial sector balance sheets and possibly push investors to take risk they will not do much for the lending and spending that drives aggregate demand. Major governments have to re-engage with economic growth.


The litmus test of policy should be its relevance to employment creation and the embracing of fiscal, lending, investment and infrastructure initiatives, as well as measures to facilitate household deleveraging.


With a more nuanced fiscal stance, there is then scope for central banks to suspend inflation targets in deference to stable money GDP growth.


Sadly, these are ideas whose political time has not yet arrived. Immediately ahead, we shall see if President Barack Obama’s modest but appropriate $450bn jobs plan, much of which extends existing programmes, will be enacted by a hitherto hostile Congress.


Meantime, global markets have some anomalies to iron out, that may demonstrate or undermine this crisis perspective. Just over 16 barrels of oil can be bought with an ounce of gold, compared to a 50-year range between 9 and 30 with an average of 15.


Gold is not overvalued on this basis. The weathervane of global growth, the Australian dollar, is as strong as that of the flight-to-safety represented by the Swiss franc, even after last week’s policy shift by the Swiss National Bank. One of these is irrational.


The eurozone’s existential and default-centric problems have not prevented the euro from breaking out of a tight trading range against the US dollar. This is bizarre.


George Magnus is senior economic adviser, UBS and author of Uprising: will emerging markets shape or shake the world economy?
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Copyright The Financial Times Limited 2011