Germany voted to support the European Stability Fund overnight, a welcome decision.
But markets didn’t soar, in fact the reaction in Europe and the US was muted.
What seems to be more pressing are signs of a gathering economic slowdown, while in the US third quarter economic growth rose by an annual 1.4%, instead of the original 1% estimate.
There’s far more to be done to pull Europe from the mire and an slowdown won’t help.
AMP Capital Investors chief economist and strategist, Dr Shane Oliver looks at what is needed to steady to the listing world economy and sagging Europe.
The chronic failure of Europe to bring its debt problems under control, an ongoing flow of poor global economic data combined with comments from global officials that there are “significant downside risks”, “the current situation has entered a dangerous phase” and the “world is in a danger zone” has seen global share markets retest or in some cases fall below early August lows.
What’s more, sharp falls in commodity prices, Asian currencies and the growth sensitive Australian dollar in the last few weeks indicate the threat to the emerging world has intensified.
There is now a sense of hopelessness that policy makers in the US and Europe have -fired all their bullets and there is not much more that can be done.
But is it really that hopeless?
The current situation – why are markets down
There are basically two reasons for the deterioration in the global economic outlook and the sharp falls/skittishness in investment markets since April.
First, global economic indicators have softened, with Europe looking like it is back in recession, the US close to it and the emerging world also slowing.
This is all evident in a slide in business conditions indicators as can be seen in the next chart.
Second, official policy makers have either been in denial or political processes have become dysfunctional, all of which is leading to either policy inaction or inappropriate action.
By adversely affecting confidence amongst other things, this has arguably turned a soft patch in global growth into something more serious:
Europe has continued to squabble regarding its debt problems.
It has yet to approve the expansion in its bailout fund that was announced months ago.
It continues to speak with multiple voices which confuse investors.
Its medicine of fiscal austerity, i.e. tax hikes and spending cuts, is making things worse.
It is not sufficiently protecting otherwise solvent countries such as Spain and Italy from market panic.
And monetary policy is too tight following the ECB’s misplaced rate hikes earlier this year.
Political bickering in the US associated with its debt ceiling and culminating in its credit rating downgrade has dealt a huge blow to business and consumer confidence.
Unfortunately it’s continuing, with President Obama announcing plans for a short term fiscal stimulus, then announcing that it and long term deficit cutting plans would be financed in large part by tax hikes, with the knowledge it likely won’t be accepted by Republicans.
This vociferous political debate is also spilling over to the Fed with top Republicans urging against further quantitative easing (QE), possibly adding to the reluctance of Fed Chairman Bernanke to deploy QE3.
Policy makers in emerging countries and Australia remain too focused on keeping a lid on inflation when the real threat is fast becoming the slump in growth and confidence emanating from Europe and the US.
Historically, there are not a lot of examples of double dip recessions, where growth recovers from recession only to slide back in a short while later.
However, those that have occurred have been either by design (e.g. America’s slide back into recession in 1981-82 as the Fed tightened to squeeze out inflation) or due to a policy mistake (such as in the US in 1937 or Japan in the 1990s).
The danger is that political ineptitude of the sort we have been seeing from the North Atlantic lately will lead to the same thing now.
So what needs to be done?
It’s not true that global policy makers have run out of policy bullets.
There is still plenty of scope to cut interest rates in Europe (where the short term rate is 1.5%) and in the emerging world.
Central banks in advanced countries that have near zero interest rates can employ more quantitative easing, i.e. injecting cash into their economies.
The pace of fiscal austerity in Europe could be slowed and the US could afford another short term fiscal stimulus in return for more aggressive moves to wind back entitlement spending over the decade ahead.
Moreover, Europe needs a bond buyer of last resort to ward off speculators from otherwise solvent countries such as Italy and Spain in order to prevent further contagion and market panic and there is nothing to stop the ECB doing this if it wanted to.
So the real issue is not a lack of firepower, but dysfunctional politics.
I would nominate five measures that would help keep the global recovery going and provide confidence to investors:
First, coordinated global monetary easing involving quantitative easing in the US, UK, Europe and Japan, and rate cuts in Europe, Asia and Australia.
Second, an increase in the firepo
