Running on Empty – Why Europe and the US Continue to Disappoint the Markets
The most recent failure was the highly-publicized and anticipated summit between French President Nicolas Sarkozy and German Chancellor Angela Merkel held last week in Paris. By ruling out jointly issued and guaranteed debt in the form of Eurobonds for the foreseeable future, Sarkozy and Merkel have taken yet another policy weapon out of Europe’s arsenal. By instead promoting an anti-competitive financial services transaction tax and advocating impossible to enforce balanced budget amendments throughout the Eurozone, France and Germany are certainly not helping solve any problems. Additionally, the idea that the way out of this clear crisis of governance is to add yet another layer of bureaucracy in the form of a “Eurozone Economic Council” headed by European Council President Herman van Rompuy shows a concerning lack of knowledge of market understanding by Europe’s two foremost leaders.
Perhaps the one solid contribution to the debate to come out of Paris was the idea to finally start enforcing the Eurozone’s founding charter by strictly monitoring government deficit levels, and withholding EU structural adjustment funds to those nations flaunting the Stability and Growth Pact’s statutory limit of 3 percent of GDP. Leaving aside the fact that France and Germany themselves are regularly guilty of exceeding this limit, many nations such as Portugal and Greece depend on these EU funds to stay afloat. A credible threat of sanctions may just be the incentive needed to ensure a return to fiscal sanity.
Meanwhile, across the Atlantic, US policymakers on both sides of the aisle continue to struggle to pass meaningful reforms to the increasingly unsustainable fiscal path the country finds itself on. Republicans continue to insist on “revenue-neutral” corporate and personal income tax reform, thus precluding raised revenue to pay down the debt and deficit. Meanwhile, Democrats are reluctant to allow for even the slightest adjustments to the entitlement programs that are far and away the largest contributors to these rising debt levels.
Since fiscal policy reform is clearly off the table in the current divided government Washington and the rest of the country find themselves struggling under, the markets have placed an unfair expectation of rescue on Federal Reserve Chairman Ben Bernanke and the monetary policy the Fed oversees. Just today, in Jackson Hole, Wyoming, Chairman Bernanke disappointed markets by refusing to start a third round of quantitative easing (QE) to stimulate the US economy. He also refused to expressly call for an increased inflation rate that many analysts see as a necessary precondition for a return to economic growth in the United States.
I continue to be amazed at the incredible overestimation on the part of policymakers on both sides of the Atlantic that they can control market reactions to their proposals.
Sarkozy and Merkel seemed stunned that European markets tanked in the aftermath of their press conference. Apparently, it comes as a surprise that the various stock and bond markets do not trust the proposed Eurozone Economic Commission (whose powers and membership remain nebulous at best) to solve Europe’s increasing debt problems. Similarly, the US administration seems to think that simply buying US treasuries using the theoretically unlimited purchasing power of the Federal Reserve will trick markets into thinking the economy has turned the proverbial corner. The first two rounds of QE failed to have a impact on the real economy each of us lives in—further proof to this point lies in today’s negative revision of US GDP growth to 1 percent (from 1.3 percent). While the bond purchases stimulated Wall Street to the tune of a 30 percent rise in stock valuation, you will struggle to find an average person who thinks the economy is returning to growth anytime soon.
Sadly, both the markets and policymakers are coming to the realization that they are simply running out of options. American public opinion has come out flatly against any additional fiscal stimulus, and the limited impact of monetary stimulus through QE has been well documented. Meanwhile, the Europeans appear unwilling to take the sorts of drastic steps necessary to save the Euro—namely introducing Eurobonds while strictly enforcing debt and deficit limits to appease the Germans who will pay significantly increased rates to borrow as a result of their introduction.
Both Washington and Brussels are running on empty, and unfortunately, the citizens who voted these leaders into office are the ones suffering. Voters should take note of the lack of leadership which is continuing the economic malaise, rather than dramatically and decisively acting to end it.
Garrett Workman is the assistant director of the Council's Global Business & Economics Program. Photo credit: The Telegraph.