An independent professional's take on the latest news and trends in global financial markets

A right old mess

The risk that the sovereign debt crisis could spiral out of control in the face of inadequate political will to resolve the crisis is clearly growing the longer that the impasse in the Eurozone (over peripheral country debt) and the United States (over lifting the debt ceiling) continues. Suggestions that we are in danger of a rerun of 2008 are not, alas, fanciful, and are growing by the day.

This is how the hedge fund manager Crispin Odey summed up the situation today, noting first the standoff in the United States, where both political parties seem blissfully unaware of the stakes for which they are playing.

The markets should be scared of such political madness, but instead the dollar benefits from greater madness emanating out of Europe. Greece is bust. Easy. However Germany and the Netherlands need to realise the necessity of recirculating the savings flows back into Spain and Italy. This current malaise provides an anvil upon which those countries can be hammered. A Euro in which deposits from southern Europe flood to Germany and are not re-exported except reluctantly by the ECB is ultimately doomed to expire. The timing of this is dangerous. Politicians are going away on holiday, but the markets will not wait.

He goes on:

This latest twist to the Euro is dangerous, coming as it does when there is evidence all around of a slowdown of credit growth in the west. QE should not be ended whilst banks are still shrinking their balance sheets. Weak final demand in the developed world should be expected, but we will not get inflation without the emerging economies bringing it to us, and to change policy as we are because of weak final demand in the west is dangerous.

The other risk is the one that Japan experienced. Without a credit cycle to help, the production cycle becomes all important. Two up years are followed by a down year and the good old inventory cycle comes back. We could be about to see a marked slowdown in the west. Remember Japan experienced four recessions in 40 years until 1996 and since then four recessions in less than fifteen years.

What we are starting to see, I think, is that the huge amounts of monetary and fiscal stimulus which have been applied to the US and European economies in the last three years have merely bought some time – time which, with occasional exceptions, has not been put to much use. It may unfortunately take another crisis to convince political leaders that they really are going to have to tackle the underlying problems which years of monetary laxity and fiscal irresponsibility have created. The time for sticking plaster solutions is passing, and the markets now seem intent on accelerating that realisation.

Written by Jonathan Davis

July 19, 2011 at 10:48 AM