Governments to blame for crashing markets

Aug 19, 2011
Ben Riley-Smith

First Reaction: Why are the markets panicking? Because trust in world governments has gone

Stocks in Europe have plummeted this morning as fears over the global economy's return to recession became very real. The FTSE 100 was down 2.5 per cent, crashing below the symbolic 5,000 mark. Germany's Dax was down 3.5 per cent and France's Cac experienced a 2.8 per cent drop.
The immediate cause is believed to be Morgan Stanley's declaration yesterday that the US and Europe were "dangerously close to recession". But some commentators claim there are more fundamental reasons for this sudden loss of confidence.
Trust in governments has gone. "Make no mistake, something serious is going on here," warned the Guardian's economics editor Larry Elliott.  "Today, governments are seen not as the solution but as part of the problem… the persistence of weak growth means that a private debt crisis has now become a sovereign debt crisis."
Worse still, Elliott continued, "markets sense that policy makers have run out of bullets to fire. They can't cut official interest rates, they find it hard to justify more quantitative easing when inflation is at current levels and almost every Western government is currently trying to cut its budget deficit."
The Times's business editor Ian King agreed: "The biggest problem is the draining of confidence in policymakers. Central banks have run out of ammunition, with interest rates already ultra-low and scope for further quantitative easing limited. That could prove critical should the eurozone sovereign debt situation worsen."
The markets are being totally irrational. "Economic fundamentals shape financial market trends," Berenberg Bank's chief economist Holger Schmieding explained. "But sometimes, financial panics or manias can be so pronounced that they distort the underlying fundamentals. For a while, the tail wags the dog. In the wake of some policy blunders, we have entered such a phase of panic."
Schmieding went on: "Fortunately, panics do not last forever. But before we get back to sanity in markets, the next few months could be exceptionally rocky."
European leaders are culpable. The Bank of New York Mellon's Simon Derrick has a worrying analogy. In recent weeks "the euro's performance has reminded us of the point where Wile E. Coyote runs off the edge of the cliff and fails to fall simply because it does not occur to him to look down."
The moment "solid ground ran out for the euro to be replaced by thin air", Derrick continued, was Angela Merkel and Nicolas Sarkozy's failure to act decisively this week. "The message was clear enough: Germany and France have scant interest at this point in doing anything other than protecting the credibility of their own markets."

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