Even as UK Hosts Olympics, Favorable Rhetoric from Across Pond Not Enough
Jotham Sederstrom Aug. 1, 2012, 7:15 a.m.
At least for a moment, investors seemed oblivious to the economy’s latest flirtation with misfortune.
Rising to their highest levels since May, equities spiked last week in spite of discomfiting readings on corporate earnings and economic growth.
The rebound in stock markets belies that, as recently as last Wednesday, Treasury yields were exploring impossible lows on speculation of renewed Fed intervention.
These are not textbook days for free market economics. Whether into stocks or commercial properties, capital is shifting in response to anticipated policy interventions and the continued distortion of private markets.
Capital flows and data diverged sharply by the end of last week. Weighed down by drags on consumer spending and investment, advance estimates showed the economy struggled in the second quarter, delivering one its most disappointing post-recession results. Consumer confidence has ceded gains from earlier in the year, pushing retail spending lower in each of the last three months. These findings have been offset, however, by favorable rhetoric from across the pond, where European Central Bank president Mario Draghi has adopted a “whatever it takes” strategy to safeguarding the eurozone and its currency. Wagering that the sovereign bond crisis and the attendant threats to global stability may be abating, investors lifted the euro to its highest level in several weeks. Spanish bond prices rose while Treasuries briefly lost some of their safe haven appeal.
The problem for Europe and for the United States: president Draghi’s rhetoric will be put to the test. His promise to do whatever it takes is both encouraging and disconcerting because nothing less may be enough. Within the scope of its current mandate, the ECB is ill equipped to offset injudicious national spending policies and the resultant buffeting of sovereign bond markets. A prohibition on central bank financing of its member governments sits at the crux of the ECB’s perceived weakness. In their positive response to the latest extravagance, investors are ignoring that Europe’s problems are structural as well as motivational and that differences of opinion remain unresolved beneath the veneer of agreement.
Given the room to maneuver, the ECB might well mimic the Fed’s strategy of bond purchases and balance sheet expansion. But opponents are well represented in politics and the wider banking system. Most notably, Bundesbank president Jens Weidmann may prove a dissenting voice. While European leaders deliberate, the cost of those deliberations continues to grow. A crisis that might have been contained in the periphery is sinking its teeth deeper in the more stalwart engines of growth. Even as the United Kingdom celebrates the opening of the new Olympiad, Britain has slipped further and ever less gracefully into recession. Among Europe’s large economies, Germany is alone in evading a 2012 contraction.
Outsized political uncertainty is not just making it difficult to plan for the future. For many businesses, it means the optimal risk-adjusted strategy involves holding off on hiring and investment. Consumers may be responding in kind, with sales of durable goods including automobiles showing signs of softening. A self-reinforcing cycle of restraint could seriously undermine growth in the coming months, just as the vitriol of electioneering further displaces rational thinking and an environment conducive to private-sector leadership. Commercial real estate investment may be a bright spot of an otherwise frustrating recovery. On the most hotly contested streets, investors may need to reassess. The further investment pulls ahead of its underpinnings, the more contrarian we risk becoming.
Sam Chandan, PhD, is president and chief economist of Chandan Economics and an adjunct professor at the Wharton School.