The best chance for economic gains and a market rally is for the Fed and the ECB to keep us hoping they will do something, instead of continuing to prove they can't do much. The central banks have used all of their resources and the likelihood that anything they can do will significantly add to economic growth is just about nil.
By Jim Jubak
9/6/2012 6:37 PM ET
Keep the promise alive. Give me decisive non-action.
That's my hope for central bank decisions in September.
Frankly, it's an attitude founded not so much on optimism that the global financial and economic crisis is about to fix itself as on a cynical calculation that the world's leaders won't do much before the end of the year. And I think the best strategy for getting to that point in the year without the current crisis getting significantly worse is lots of central bank promises coupled with very little action.
That way the Federal Reserve and the European Central Bank keep the hope of powerful central bank intervention alive -- which bolsters the prices of financial assets and optimism about the economy.
So far, so good; for all the attention the market gave the ECB's announcement Thursday, it was only a promise with contingencies. There was no action.
And all promises with no actions doesn't reveal the depressing truth: that central banks have used their powder, emptied their toolbox, burned all their fuel -- and the likelihood that anything they can do will significantly add to economic growth is just about nil.
The bad alternatives
I can think of two possible outcomes if the Federal Reserve and the ECB summon up the last ounces of policy mojo that they have -- and neither is good.
First, at a minimum and in the short term, if the central banks act instead of just promising to act, all those shorts and bears who had moved out of the financial markets in August to avoid getting crushed if the Fed and the ECB did move would now be free to go negative again. That includes not only traders who might short equities but also bears who might want to bet against the bonds of Spain and Italy.
And that freedom to go negative could produce a repeat of the worst of the Spanish and Italian bond crises in relatively short order.
Second, more serious and in the slightly longer term, if the central banks act and demonstrate that they can't fix the European debt crisis or the global economic slowdown with a wave of their balance sheets, then we've taken away an important psychological support for the belief that the crisis and associated slowdown are going to get better soon.
After all, if the Fed does implement a new program of bond buying under the rubric of QE3 and it doesn't work (say, for example, unemployment stays stuck at July's 8.3%), then how do we get out of this slough of slow growth in the United States? If the ECB does start a program of unlimited buying of three-year and shorter Spanish and Italian bonds, and the effort doesn't reduce interest rates enough to get those economies moving again, then tell me why a 35-year-old unemployed Italian or Spaniard should think things will get better soon?
It would be up to global political leaders to act -- and I don't see a window for that until near the end of the year.
Keeping hope alive
Better the illusion of hope than no hope at all? You bet. The hope that the central banks could yet throw out a rescue line would buy governments and the global economy time to eliminate debt, time to regain confidence and time to put policies in place that might actually address issues such as productivity and unemployment. (I'll explain how this might work at the end of this column.)
But first, let's look at the odds for constructive non-action.
So far, the odds are high.
On Aug. 31, at the Kansas City Federal Reserve's Jackson Hole conference, Fed Chairman Ben Bernanke laid out what the Fed could do and the circumstances under which the Fed might act -- but did nothing.
On Wednesday, the day before the meeting of the ECB's board of governors, details of the bank's plan leaked to Bloomberg News. That was in itself brilliant (and I suspect deliberate), because it created the impression that the bank was preparing to act. ECB chief Mario Draghi's news conference after the meeting furthered that impression. He laid out such a clear and reassuring plan for action -- the bank would buy relatively short-term Spanish and Italian debt, it would renounce any claims to seniority for its own bond holdings, and it would take on new regulatory powers -- that no one called out that this plan was nothing but a more detailed version of promises made earlier this summer.
The plan didn't just avoid mentioning concrete actions to put those promises into motion. It also included an absolute barrier to action.
Yes, the central bank would buy unlimited quantities of Spanish and Italian government bonds, but only after the governments of those countries formally asked for such a rescue. Those governments haven't done that, and have instead made statements ranging from "we see no need to do that" to "we see no need for that at this moment." Both Mariano Rajoy's government in Spain and Mario Monti's government in Italy suspect, rightly I think, that asking for a bond rescue with conditions that smell even faintly of the conditions imposed on Greece would be political suicide.
Yes, the central bank would buy unlimited quantities of those bonds after the European Financial Stability Facility and the European Stability Mechanism had acted. But the first is supposed to be going out of business, and the second isn't yet in place. In fact, the European Stability Mechanism is in limbo until the German constitutional court rules on Sept. 12 on the constitutionality of the fund. Until then, the Bundestag can't even vote to approve the European Stability Mechanism, and, without the Germans, this fund is going nowhere.
We're not out of the woods, of course.
There's the relatively remote possibility that the German constitutional court will actually find the permanent European bailout mechanism unconstitutional. That would provoke a true crisis -- all promises would quickly seem to be dead. And that might force the ECB to act to contain a catastrophe.
There's still next week's meeting of the Federal Reserve's Open Market Committee. It is possible that U.S. economic numbers could take a turn from grim to grimmer in the next week so that the Fed would act. I think that's unlikely after this week's good news on U.S. auto sales -- a 19.9% increase in August from August 2011 -- and so close to the November presidential election. I think the most that we can expect from the Federal Reserve on Sept. 13 is heightened rhetoric about the need to move if the economy worsens.
And, of course, there's the European agenda that includes a summit on Oct. 18 and then another special summit on Nov. 22. But nobody really expects anything but promises from a European summit, right?
The Federal Reserve's Open Market Committee meets again Oct. 24 and Dec. 12.
But I think there's a very good chance that we'll muddle through on a diet of promises and non-actions until December.
Is that good or bad? It depends.
The limits of inaction
If the promise of action -- without the unmasking of action as ineffective -- can keep Spanish bond yields from breaking much above the 7% to 7.25% range, I think we'll get through the fall without a full-scale meltdown in the European bond markets.
If the U.S. economy picks up strength in the fall -- and there are signs that it will (including reports of strong back-to-school sales, with a 5.9% increase in comparable-store sales in August, and those August auto sales numbers I mentioned earlier) -- then we might actually get a financial market rally in the fall. Higher asset prices wouldn't solve much -- they would contribute to the recovery in the U.S. housing sector, it's true -- but a shot of animal spirits would, temporarily at least, boost economic growth as we head into the Christmas shopping season.
If growth in China looks like it is stabilizing in the fall -- as opposed to heading for a hard landing -- that would certainly have a positive effect on commodity prices and commodity economies. And it would remove a big worry from the financial markets.
The muddling through gets harder after that.
Over all this looms the U.S. fiscal cliff. Depending on how the election goes in November (and by that I don't mean which party wins so much as what conclusions can be drawn from the results about where political advantage lies), I can see the United States skirting disaster with a last-minute compromise or pulling a "Thelma & Louise" and heading right into the canyon.
It's too early to say "Buy gold and bury it in the backyard," but December could be very dangerous.
Promises instead of actions -- my wish for the next few months -- would probably be relatively effective in stabilizing the financial markets, but they would do nothing to actually address the problems in the world's real economies. Muddling through isn't really a hope that the world's economies will somehow fix themselves. I think that's possible in the United States and China for a while. But it's unlikely in the eurozone. And I'm not hopeful that the "for a while" would last very long.
What are we waiting for?
The major downside of my hope for promises and not action is that while this does buy time for leaders to come up with policies to fix global economies, the pattern of promising rather than acting that characterizes this crisis pretty much guarantees that we won't use the time gained very effectively.
And there is a good chance that as long as the central banks haven't shot their last arrows, our political leaders won't feel compelled to come up with their own solutions. You could make an argument that the big advantage of actions that show the central banks are out of ammunition now is that political leaders would be more likely to move sooner.
You could make that argument. But I won't. I don't think U.S. politicians will act until after the November elections. China's leadership is in the midst of its own transition, which is part of the reason for the relatively low-key response to China's economic slowdown. That transition won't be complete until the meeting of the National Party Congress in October.
So my argument would be that it would be best if we can muddle through, into November or December, on promises while keeping the last moves from the world's central banks in reserve. We're more likely to get effective action from global leaders toward the end of the year than now, but that's by no means certain. So I'd rather head into the end of the year with the limited firepower central banks still have in hand than see it squandered as a wet squib in the next few weeks.
I think we can just barely avoid a return to the darker days of this crisis. And the best way to avoid that pain is to promise loudly this fall and do nothing.
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