The Western world is at mounting risk of a double-dip recession after key measures of confidence collapsed in both the United States and Europe, with Germany suffering the steepest one-month fall since records began in the 1970s.
By Ambrose Evans-Pritchard, International Business Editor
9:09PM BST 30 Aug 2011
The drop was far steeper than expected and follows grim warnings over the weekend from Christine Lagarde, new chief of the International Monetary Fund, that the global crisis is entering “a dangerous new phase” .
The fund has slashed its growth forecast for America and Europe, according to a leaked draft of its World Economic Outlook. It has called on both the US Federal Reserve and the European Central Bank to stand ready for “further easing of monetary policy” – implying a fresh blast of quantitative easing (QE) by the Fed.
The minutes of the Fed’s meeting in early August show that a number of committee members called for more “substantial” stimulus, suggesting that they pushed for further bond purchases or ‘QE3′.
The Fed’s so-called “Gang of Three” hardliners has already shrunk to two. Minneapolis Fed Narayana Kocherlakota said on Monday that deflationary pressures are building again. “Increasing policy accommodation might well be appropriate,” he said.
In Europe the picture is as bad if not worse. The eurozone is already on the cusp of recession even before austerity bites in Italy and France, and bites harder in Spain, Portugal, Greece, and Ireland.
The European Commission’s economic sentiment index (ESI) dropped below the contraction line in August. “A loose monetary policy seems to be the only medicine left to prevent a painful fall back into recession,” said Peter Vanden Houte from ING.
Jose Vinals, the IMF’s head of capital markets, rebuked Europe’s leaders for failing to beef up bank defences and allowing the debt crisis to fester. “You cannot afford to have a world economy where these important decisions are postponed because you’re really playing with fire,” he said.
Charles Dumas from Lombard Street Research said a recession is inevitable on both sides of the Atlantic next year, blaming “fiscal deflation” without offsetting monetary stimulus – either because the central banks have used up their ammunition, or refuse to act.
Mr Dumas said the ECB has been too tight and blundered by raising rates in July to counter an oil spike just as the economy was sputtering. Unit labour costs are falling and the M3 money supply is stagnant.
Jean-Claude Trichet, the ECB’s president, signalled this week that rate rises are off the table but he has little scope for outright stimulus. The ECB is acutely vulnerable after German President Christian Wulff accused the bank of going “far beyond” its mandate and engaging in “legally questionable” purchases of Spanish and Italian bonds.
The unspoken contract of EMU is that it should never lead to inflation in Germany or threaten German control over the project, yet this contract is now being tested. Any suspicion that the ECB is loosening policy to nurse southern Europe through its debt crisis will trigger a political backlash in Berlin, though with Germany itself now flirting with recession as exports buckle this may help paper over EMU divisions for a while.
Hans-Olaf Henkel, former head of Germany’s industry federation (BDI), wrote in the Financial Times that his support for the euro had been “the biggest professional mistake I have ever made”. He described EMU as an unworkable experiment that is turning Europe’s nations against each other.
He called for a ‘Plan C’ under which Germany, The Netherlands, Austria, and Finland break away and form their own currency, leaving the South with a weaker euro and a chance to restore growth. Some Northern banks would have to be nationalised for a while to prevent losses on Southern debt causing a financial crisis.
Stephen Jen from SLJ Macro Partners said the next phases of the eurozone crisis is likely to come when the debtor states conclude that it is no longer worth putting up with the pain of EU-imposed austerity. “I think this will happen in weeks rather than months.”
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- Germany fires cannon shot across Europe’s bows (jhaines6.wordpress.com)
- Treasuries, Gold Rise on Consumer Confidence Report; Stocks Fall (businessweek.com)
- James Surowiecki: Europe’s Big Mistake (newyorker.com)