By Terry Connelly, dean emeritus of the Ageno School of Business at Golden Gate University
There are some good signs in the economic news from the past week — even evidence that some of the logjams that have impeded solutions to our biggest economic problems in Europe, the U.S. and China perhaps are coming unstuck.Mario Draghi, president of the European Central Bank (ECB), has accomplished three big positive changes through his detailed plan for potential unlimited sovereign bond purchases to the ECB.
First of all, he has managed to separate the German government position from the doctrinaire intransigence of the Bundesbank. None other than Wolfgang Schauble, the Finance Minister no one would ever mistake for a Keynesian, has come to the ECB's defense over the weekend in the face of harsh criticism of the Central Bank from his own coalition partners as well as from as the Bundesbank and the German version of the Murdoch press. The ECB's aggressive move to stop the speculative bleeding in interest rates on Spanish and Italian debt is now official government policy in Germany.
Secondly, this German support and the precise terms of the buying program have had the effect of really putting a scare into speculators and a spine into longer-term investors as they consider their positions in Spanish and Italian government bonds. Since Draghi refused to specify any limit on the amount of bond purchases, speculators can't game the system and push him to a "line in the sand" he hasn't drawn — it becomes much harder for them to calculate how far to push up borrowing rates. And because Draghi also made clear that the ECB would not stand ahead of private creditors in the event of default as it previously had insisted, investors looking to bet on longer term recovery were encouraged that they would not turn out to be the "dumb money" taken for a "haircut" at the ECB barber shop.
Thirdly, because Draghi made clear that the bond buying program would be triggered only by the request of the effected sovereign government, which in turn would lock-in explicit fiscal reform commitments under outside supervision, he accomplished what Hank Paulson was unable to fashion in the U.S. Treasury's last-minute efforts to stave off the financial meltdown in this country. Draghi was able to invent a "bazooka" that is potentially expensive but that he might well not have to use.
Europe's Bases Are Covered
Paulson's bluff was called by the credit markets after he and the Fed were overwhelmed by the "run" on Lehman and the knock-on effects of its bankruptcy on AIG, all the other financial institutions and the global financial system. Paulson was forced to actually use his TARP "bazooka" to save the banks, at huge public expense — TARP money even wound up being spent to save General Motors and Chrysler. But Draghi has called the speculators' bluff by engendering a real fear premium cost into in their short positions. At the same time, he has created a powerful incentive for the sovereign governments to proceed much more aggressively on structural reforms in their economies so as not to risk the domestic political humiliation of having to ask for ECB help at the price of turning over fiscal sovereignty to outsiders.
It would seem for the moment that Draghi's adroit moves, despite the heated rhetoric from the losing side in Germany, can really be a "game-changer" for the euro. All that stand in the way of that is the forthcoming decision of the German high court on whether it is legal for Germany to participate in the euro rescue funds as promised. We'll know that answer September 12.
Toward a U.S. Solution
On the next day (Thursday the 13th), we will also know whether the Federal Reserve under Ben Bernanke's leadership will extend its commitment to maintaining low interest rates into 2015 and also whether it will initiate any further bond buying program of its own, most likely focused on maintaining low rates on home mortgages. There is nascent evidence of a housing price recovery, and while mortgage rates are already at historical lows the wealth creation effects of a housing upturn can be such a powerful force as to encourage the Fed to take out an "insurance policy" on that sector's prospects for a strong recovery, especially as unemployment still remains stubbornly above levels that would reflect a healthy economic recovery.
Of course housing, unemployment and GDP are "chicken and egg" related: housing growth yields more jobs, and more jobs yield housing growth. The critics of the Fed who argue that it can do little at this point to push employment upward in effect make the case that the Fed should act to underpin the emerging recovery in home prices and related housing price construction. It worked before for Greenspan's Fed when he was confronted with the $7 trillion wealth wipeout from the dot-com crash and 9/11 events in 2001. The Fed's low rate policies produced a quick $4 trillion wealth effect restoration over the next four years. If today's Fed follows suit, it will need to plan an exit strategy from its stimulus moves so that we do not get a repeat of the wretched excesses of the housing finance bubble that Greenspan somehow didn't see coming.
Like Scarlett O'Hara, we can worry about that tomorrow — unemployment is the problem right now. But there may be a silver lining in the recent jobs report, which showed meager net job growth and a large decrease in the number of people who apparently have given up actively looking for work. As it happens, the largest cohort of work force dropouts was not in the "grown-ups" sectors, including the oldest, but rather in the 16-24-year-old group. Could it be that the "seasonal" adjustments that the Labor Department used to factor in young people going back to high school or college were in fact overstated? The fact is that state universities are severely cutting back the availability of admissions. And evidence is emerging also that the crisis in student loan defaults are scaring many away from taking on college debt. We will learn on September 12 whether the Bernanke Fed will risk political backlash, as in Germany, in order — like Draghi's ECB — to do "all that it takes" to help the U.S. economy recover.
Hope in China?
Finally, we have seen the Chinese, despite being little over a month away from an important 10-year leadership transition, commit to a $157 billion infrastructure-spending program to refocus on domestic economic growth. This is encouraging in two ways. This program is not the previous form of stimulus focused too much on bloated state-owned enterprises, which produced a surge in inflation that the Chinese were forced to temper at the cost of continued economic expansion. Instead, it represents a maturing shift to domestic consumption that bodes well for rebalancing exports with Europe and the U.S. (U.S. equipment supplier stocks like Caterpillar and Joy Global were up sharply on the news.)
In effect, the Chinese have signaled that they will be increasing domestic purchasing power — and this can only be done via the long-sought U.S. objective of an appreciating Chinese currency! But let's not take a victory lap over here — let's just say a silent thanks and let them get on with it. Sometimes there is light at the end of the tunnel. Maybe the "era of big pessimism" can soon come to an end.
Terry Connelly is an economic expert and dean emeritus of the Ageno School of Business at Golden Gate University in San Francisco. Terry holds a law degree from NYU School of Law and his professional history includes positions with Ernst & Young Australia, the Queensland University of Technology Graduate School of Business, New York law firm Cravath, Swaine & Moore, global chief of staff at Salomon Brothers investment banking firm and global head of investment banking at Cowen & Company. In conjunction with Golden Gate University President Dan Angel, Terry co-authored Riptide: The New Normal In Higher Education.
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- Budget, Tax & Economy
- Mario Draghi
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