An article in Bloomberg BusinessWeek from two months ago, "How the Euro Virus Travels," still resonates today. According to the article, President Obama blamed the low number of jobs created in May (a disappointing 69,000) on Europe.
“A lot of that’s attributable to Europe and the cloud that’s coming over from the Atlantic,” he told the crowd. “The whole world economy has been weakened by it, and it’s having an impact on us.”
The job numbers were better this month, even though the unemployment rate rose ever-so-slightly to 8.3%. One may suppose that the policies of the Obama administration may have also contributed to the economy's lackluster performance, but perhaps the President's point is worth exploring in greater detail.
The article explains the a loss in exports from the United States to Europe is not one of the main causes of our economic slowdown. As Tom Porcelli, RBC Capital Markets chief US economist, points out:
Europe’s troubles may hit U.S. exports in a more roundabout way. Emerging markets such as Brazil, Mexico, and China have accounted for the bulk of U.S. export growth over the last few years. Since the recession began in 2007, exports to Brazil have increased by more than 70 percent. Emerging market countries get the majority of their lending from European banks. So if Europe continues to deteriorate and its financial system tightens, some emerging markets could lose a key source of financing, which in turn could squeeze their ability to keep buying U.S. goods. “That’s a very important aspect that can’t be overlooked,” says Porcelli.
Here's another aspect that can't be overlooked:
...a new study from the Federal Reserve Bank of San Francisco found that Europe’s woes have increased the borrowing costs for U.S. corporations through a phenomenon known as the contagion coefficient, essentially a measure of correlation. From 2009 to 2011, every percentage point increase in the amount that European corporations were charged to borrow money translated into a 0.68 percentage point rise in the rate U.S. corporations paid, meaning that about two-thirds of the rise in European corporate borrowing costs were passed on to U.S. companies.
This article has a wealth of information. The link for it is: http://www.businessweek.com/articles/2012-06-07/how-europes-contagion-may-hit-the-u-dot-s-dot-economy.
Given the above scenario, what steps should be taken to avert another crippling recession?
None. Avoiding the financial purge perpetuates the problems. Choose your analogy for doing the painful, but right, thing: forest fire, fever and flu, tough love, sour medicine, etc. There are mathematical realities that govern what is happening in Europe and what will happen in Japan, China, and the United States. The world went on a global spending and debt glut- it's time to pay the piper. Delaying it only deepens the eventual crisis. The crisis we face could be reasonably be linked to the financial bubbles in Scandinavia and Japan in the early 90s, Asian Contagion/Russian default of the 1997-98, the tech bubble, and finally, the subprime mortgage crisis. Why? Because fiscal and monetary policy in response to all of these events was counter-cyclical delaying measures to 'ease the pain'. And each time, it encouraged international money flows into the next 'hot asset'. Look at this tepid 'recovery' we are in- 8.3% unemployment, record fiscal deficits, AND the world is rolling back over into recession (or rather, we never left)? There has not be a recovery this weak in modern times (including the first Lost Decade in Japan). I wonder why that is. Naturally, for the sake of brevity, I did not discuss in detail why I think some of these points/events are linked in a rigorous manner. If you would like me to, just reply and I'd be happy to discuss.
On a further note, don't listen to the political class about jobs numbers. If the numbers are good, the politicians claim to be entirely responsible; if they are bad, the politicians lament that there was nothing that could be done to prevent an externality (or it was the other party's fault). Also, I would radically discount how much weight I would assign them, given how 'adjusted' they are. 8.3% in no way meaningfully represents the true unemployment rate, by any reasonable measure.
rls for president 2012
Rls, I'd like to hear more from you. Why do you believe "some of these points/events are linked in a rigorous manner?"
I'd be happy to. These events have their roots in the internationalization of the financial system; over time, each country has become more closely tied to international money flows. Correspondingly, there have been more contagions and international financial crises. This is a natural symptom. As money flows more freely internationally, there is more hot money flowing from place to place, filling up the various corners of the world looking for returns- and rapidly fleeing when risk rises. This is neither good nor bad, but a result of two things: financial liberalization (less restrictions on money flows) and financial innovation (new financial products). In truth though, financial innovation is nearly equivalent to financial liberalization. When financial institutions create new products that are not understood or regulated by their respective governing body, then they have increased the scope of financial activity relative to the area that is regulated. As long as that new product is profitable, money will flow into it, until either it is abused and a catastrophe takes place or it is restricted in such a manner as to render it less appealing (usually one of the two). This process has been accelerated with the widespread use of monetary policy and fixing interest rates- typically cheaper than it ‘should’ be- increasing the outstanding money supply. As you know, being the biggest financial center and issuer of the world's reserve currency, U.S. monetary policy largely governs the global financial system.
In the late 80s and early 90s, U.S. banks lent a lot of money to Latin American countries, which caused a trade deficit and exposed those countries (and their banks) to additional currency risks (due to the net inflows and demand for their currencies). A trigger causes a change of perception/risk tolerance in investors (a failure of a bank, a loss that was not previously considered possible), money flows reversed, local banks failed, and government defaults (or got lifelines that avoided default). As bubbles pop, international capital flees the deflating asset and enters an assets that “performed well” during the period of chaos- hence the cascade of bubbles and crashes. Initially, the new flows are justified by the fundamental prospects of the newly minted favored asset. At some later point, money flows only occur because the new money expect someone else to bid up the price in the future- the "greater fool" syndrome. Then- trigger, panic, followed by a bust. So, this pattern repeated in Scandinavia, Japan (they were going to take over the world by the 1990s according to some measurements), the Asian Contagion (Southeast Asia i.e. Thailand, Philippines, etc. was going to repeat the success of the Asian Tigers), the U.S. tech (a 330 P/E is cheap for a growth stock, value investing is irrelevant in the Information Age), and housing bubble (housing prices have never gone down on a nationwide scale since WWII). I am not painting a direct causal link between all of these events, but they are more than tangentially related. There has been a staggering increase in the severity and frequency in financial and monetary crises since the 1970s.
I believe that it no coincidence that since the 1970s, we have had the most activist fiscal and monetary interventions which tend to be countercyclical- i.e. more spending and lower interest rates during recessions. These policies are designed to prevent the liquidation of debts and failed investments which is so essential to free markets- the creative destruction, as Schumpeter called it.
For further reading I would highly recommend “This Time is Different: Eight Centuries of Financial Folly” by Rogoff and Reinhart. This phenomenon of cascading bubbles and subsequent crashes is also examined in "Manias, Panics, and Crashes: A History of Financial Crises" by Charles Kindleberger.
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