More Noise
As summer vacations have ended, noise in financial markets has become especially pronounced.
Late last week, world central bankers gathered at their annual Jackson Hole, Wyoming meeting. The markets' obsession with whether the Federal Reserve would propose, or at least hint at, a third round of quantitative easing (QE3, whereby the Fed purchases US government bonds with newly created money) was once again clearly evident. As it turns out, Chairman Bernanke neither confirmed nor denied imminent action. But, at least in this writer's view, his focus on "the enormous suffering and waste of human talent" of still high unemployment does indicate a QE3 announcement, perhaps as early as the next Federal Open Market Committee meeting on September 13.
Notably absent from the Jackson Hole gathering was Mario Draghi, the head of the European Central Bank (ECB), who cancelled his scheduled attendance just prior to the meeting. This of course fueled greater speculation that he was assigning priority to another program of ECB purchases of European sovereign bonds - a "European" QE. (A quick primer - by buying bonds, a central bank increases demand for, and hence the price of, these instruments. In any bond market, as the bond price rises, the yield - the effective cost of financing - declines, facilitating further borrowing by governments to fund debt and current program spending.) Press reports just this morning are signalling that the program, possibly to be outlined following the ECB meeting tomorrow, will be one of "unlimited bond purchases". As a result, Spanish bond yields have dropped, after reaching record highs in July, as have similar Italian, Portuguese and Greek yields.
All this central bank activity in America and Europe is no doubt useful in calming markets. But, for the longer-run, it does not, and cannot, address the fundamental economic and fiscal issues - sluggish or no growth, unsustainable levels of government debt, record-high annual deficits in many countries, and ever-expanding entitlement expenditures that seem politically impossible to constrain. Italy, Spain, Portugal, Greece and Ireland are poster children of this debt/recession scenario, but the American economy is stressed similarly, albeit with no upward pressure yet on very low US bond yields.
Such fiscal imbalances were years in the making, and fixes can occur only over several more years, assuming governments act now to restrain spending. Paul Ryan knows this (see my blog of August 14). It can be done - Canada's Liberal government in the 1990's is a remarkably successful example of political will that produced the transformation of an economy from debt-laden and crises-prone to productive and relatively balanced.