Panic, policy cuffs could force new recession

Economists on both sides of the Atlantic have slashed growth predictions.

WASHINGTON: Another punishing week in stock markets has left European and US leaders looking less and less able to staunch fears of recession that analysts say could turn into a self-fulfilling prophecy.

While economists said the world’s mature industrial countries had not yet completely stalled, increasingly they were using the term “negative feedback loop” to define their worry.

In layman’s terms panic in financial markets is scaring consumers and businesses into locking up spending, forcing a new economic contraction two years after the “Great Recession” ended.

Governments, themselves under the gun from bond markets and political pressure to cut spending, have diminishing kits of tools to counter the pessimism, they said.

That combination sent share markets plummeting, putting the broad-based S&P 500 index of US stocks down 4.7 per cent for the week and 15.3 per cent lower after a month of economic turmoil.

Britain’s FTSE 100 is now down 12.9 per cent over a month; France’s CAC 40 18.4 per cent; and Germany’s DAX has been hit even harder, off 9.8 percent for the week and 23.8 percent in a month.

With trillions of dollars lost in paper wealth, sellers have moved their money into the safest havens they can find - US Treasury bonds, Swiss francs, Japanese yen and others - meaning it does not help growth.

Economists on both sides of the Atlantic slashed growth projections. “Our revised forecasts show the US and the euro area hovering dangerously close to a recession - defined as two consecutive quarters of contraction -  over the next 6-12 months,” investment bank Morgan Stanley said.

“A negative feedback loop between weak growth and soggy asset markets now appears to be in the making in Europe and the US. This should be aggravated by the prospect of fiscal tightening in the US and Europe,” it said.

“In the absence of appropriate policy intervention from the European Central Bank (ECB), the Federal Reserve and the US government, it is entirely possible the current downward spiral in the economy and financial markets will become self-reinforcing,” said John Silvia, chief economist for Wells Fargo bank.

In Europe and the United States there is almost no room to lower interest rates to stimulate growth; central banks can fine-tune policy to try to push banks into putting more money into the commercial market, but that it is not clear that it will stimulate economies.

In Europe, where bailouts of Greece, Portugal and Ireland have already strained the richer governments, politicians and the public are reticent to pump more money out that they do not have.

The ECB does not have the power to print money to fuel recovery; and Tuesday’s meeting between French President Nicolas Sarkozy and German Chancellor Angela Merkel ruled out allowing it to issue region-backed eurobonds to raise money for growth and bailouts.

Meanwhile there was pressure on Europe’s still-liquid governments to pare deficits by mainly cutting spending, especially France, the eurozone’s second largest economy.

The same was true in the United States, where some are calling for an industry-building programme on par with the World War II effort that pulled the country finally out of the Great Depression. But given the August 5 credit downgrade of the government by Standard & Poor’s over its growing deficit, and the refusal of conservative Republicans to allow spending, that is a non-starter.

More negative sentiments enter picture:

New data showing eurozone growth crawling at 0.2 per cent in the second quarter, and Germany only at 0.1 per cent;

Warnings, most notably from Morgan Stanley, that the US and Europe were on the precipice of a new recession;

The failure of the German and French leaders to offer markets a convincing fix to the eurozone debt problems at their summit on Tuesday.

Published in The Express Tribune, August 22^nd,  2011.