Sunday Times (London)
May 30, 2010
by Irwin Stelzer
Economists call them exogenous shocks. Harold Macmillan, prime minister from 1957 to 1963, called them “Events, dear boy, events”. Donald Rumsfeld, former US defence secretary, called them “unknown unknowns”. Investors care less about the precise label and more that the world seems a scary place.
Never mind that almost all the economic news in America is good: the economy is growing again; company profits are up and mortgage rates down; retailers’ first-quarter profits are 26% above last year’s level, and bankers are concealing their glee at the best quarterly profits in two years; home building is up and property developers are snapping up land that already has infrastructure in place; inflation is at a 44-year low; and the Chinese are again buying US government IOUs.
Yet all is not for the best in this best of all possible worlds. The happy economic news is accompanied by disturbing news on a variety of fronts. Israel is increasingly nervous at the inability of America and its partners to contain Iran’s nuclear weapons programme and is considering the feasibility of an attack to delay the regime’s acquisition of a bomb it has promised to use to destroy “the Zionist entity”. South Korea has responded to North Korea’s torpedoing of one its vessels by blocking passage of that regime’s ships through its waters, which might trigger a war that would involve the US troops stationed on the border between the two countries — unless President Barack Obama pulls them out as part of his plan to “engage” the North Koreans.
The war on terror goes on, with New York and its financial centre certainly among the leading targets of terrorism. Worse, America now seems so impotent that its former allies, Turkey and Brazil, have signed up with what Osama Bin Laden calls “the strong horse”, which seems to include anti-Americans from Hugo Chavez to Mahmoud Ahmadinejad, the Venezuelan and Iranian presidents.
In short, now that the world’s policeman has left the global beat, there is no telling what might happen. Worse still, that cop has decided on a domestic beat, without too much regard for the consequences of his inability to distinguish the good guys from the baddies.
The financial overhaul bill wending its way to the president’s desk will likely lower banks’ profits and their credit ratings, forcing them to be even stingier with borrowers. The Securities and Exchange Commission has adopted new rules that will make it harder for money market funds to continue providing about one-third of European banks’ wholesale funding lest the funds run afoul of new regulatory criteria.
Congress is about to take up the cap-and-trade bill that will drive up energy costs, and plans new taxes on multinational businesses, investment managers and hedge-fund operators. Markets loathe uncertainty, which these laws and regulations provide in ample amounts since nobody can predict their effects, least of all the congressmen who freely admit they have not read them.
Then there are the problems in euroland. We have known since the financial crisis that some institutions are too big to fail. When Greece was bailed out by its eurozone colleagues, the European Central Bank and the International Monetary Fund, we found that there are countries too small to fail. With Spain experiencing difficulties, we are told that medium-size countries are, well, too medium-sized to fail.
Allan Meltzer, economics professor at Carnegie Mellon University, famously said: “Capitalism without failure is like religion without sin.” He was right: there is now every reason for governments and big banks to believe they can spend and take risks, failure no longer being a possible penalty. It’s called moral hazard, a problem so far ignored by a panicked eurocracy and uncorrected in the huge financial reform bill before Congress.
Adding to uncertainty is the discovery that American banks are more exposed to the problems of Europe’s banks than had been realised. Indeed, our banks are now so nervous about the possible weakness of so-called counterparties that they are demanding higher interest rates on interbank lending.
Of course, investors who value a good night’s sleep can flee to the dollar, as many are doing. But as they nod off they just might have a nightmare or two. They might have heard on the late news that the American recovery remains “fragile”, never mind the cheery data. The Federal Deposit Insurance Corporation’s list of “problem” banks now runs to 775 institutions, some 10% of the American industry, compared with 252 at the end of 2008. This is in addition to the 72 banks that regulators have closed so far this year, and the 237 that have failed since the beginning of 2008. These mostly smaller banks have taken on property loans that are unlikely to be repaid in full.
More important, there is no end in sight to the deficits the government is piling up. The president is determined to keep spending, despite the ocean of red ink. Indeed, last week presidential adviser Larry Summers urged Congress to pass a second stimulus package lest, he said, the recovery is aborted. With Democrats determined to continue spending, and Republicans opposed to new taxes, with the bill for healthcare and other entitlements set to soar as the population ages, only a series of victories by candidates backed by the Tea party has any real prospect of bringing the growth of government, and associated deficits, under control. Meanwhile, the printing presses keep churning out dollars, as the Federal Reserve Board hunts for the perfect exit strategy and just the right time to implement it.
This means that inflation is one of the nightmares that those fleeing to the safety of American government bonds will have. Some wake up in a sweat and telephone to buy gold at $1,200 an ounce, or other commodities. Others give up, and decide that since they cannot really protect themselves against exogenous shocks, events or unknowns — all they can do is fret. Or forget about it all over this long holiday weekend.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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