On the Recent Financial Market VolatilityA Crisis of ConfidenceOn Friday, August 5, 2011, the US-based rating agency Standard & Poor’s downgraded US sovereigndebt from AAA status for the first time in its history.Subsequently, the financial markets saw massive drops beginning on August 8, 2011, with 11.2% dropsin value in the Dow in the US, while all European markets were also hit with major declines. The GermanDax declined by 22%, the British FTSE declined by almost 15%. Likewise, in Asia, Korean and Japanesemarkets both tumbled by 3.7%.http://www.bbc.co.uk/news/business-14418539http://www.bbc.co.uk/news/business-14414669Source: BBC NewsReboundhttp://www.bbc.co.uk/news/business-14502255Nevertheless, by Friday August 12, 2011, the markets were in stark rebound. What is happening here?Has something changed in the market fundamentals?Change in the Market Fundamentals? Yes and NoThe main fundamental which has changed in the financial markets is the credit rating for US sovereigndebt.
Change in ConfidenceWhat really happened was a change in the way investors feel about future prospects for stability in thefinancial markets. Basically, we can take both the sharp downward swing and the dramatic increase involatility as a market signal that financial stabilization measures in both the US and the EU have notreally addressed the major issues. In other words, according to the market outlook, bailouts in the UShave failed and the debt negotiations have also failed. The market outlook vis-à-vis the EU is thatEurope’s reaction to the Greek crisis and the sovereign debt problems of the Mediterranean rim, as wellas general European financial stabilization have been altogether insufficient.The USUnderlying the downgrade US sovereign debt – and the subsequent widespread selloffs in the US stockmarkets – is a general loss of confidence in the soundness of US economic management. While thebanks have been recapitalized and the money quantity has been dramatically increased, microprudentialregulation has been all but neglected. In other words, the American attempt to soundly regulate thefinancial crisis has failed. Why did the 400 provisions of the Dodd-Frank act get reduced to 38? Why hasno further regulation been enacted? What plans are there to join and adhere to international financialregulatory standards?As for the bailouts, we see that the banks have been re-capitalized, and that the financial institutionshave been rebuilt, and that QE has left massive amounts of liquidity in the financial market, but thatnone of that money has been sent into the real economy. The result: unemployment and productionfigures never really improved. This is because insufficient regulation has been put into the US financialand banking sectors. Thus, all the new cash in the system does not actually reach the problem areas forwhich it was actually intended. This leads monetary-expansionary needs to be much larger than whatthey could be, while the crisis-response effect is largely mitigated and risk of crisis is increaseddramatically.And as for the debt-ceiling negotiations, the cuts will simply mean a drop in growth. The cuts will alsomean an upwards re-distribution of income and wealth in the US economy. The real answer was toperhaps increase revenues. In short, both the Democrats and the Republicans have come to anagreement to launch an upwards redistribution of wealth, despite the fact that Obama’s democraticmandate was exactly the opposite of that.Furthermore, getting rid of the Gephardt Rule (automatic debt-ceiling rule) means that this sort ofshowdown might occur again and again. The Republicans took a calm budgetary process, and turned itinto an annual risk of default showdown. They created an economic crisis where there was none before,only to redistribute wealth upwards. What is worse is that the Democrats went along with it all.This is why the US was downgraded by the rating agencies. A drop in growth for the coming few years. Future prospects of legislative showdowns on the budgetary issues
A dramatic increase in the money supply. Besides QE1 and QE2, the US has pledged to keep interest rates low until 2013. The lack of microprudential banking and financial banking regulation A bailout which did not reach the real economy, due to insufficient regulatory standardsI would say that Washington’s mismanagement played a huge role in this situation.EuropeWhile the drop in the financial markets was particularly bad on Wall Street, it was also severe in Europe.Overall, there are good reasons for which the financial markets have also lost their confidence in theEuropean markets.In some ways, Europe’s situation resembles that of the US. Specifically, the money supply has increaseddramatically (both in the Eurozone and in the UK), while microprudential regulation has generally notimproved much.With respect to the sovereign debt situation, European austerity measures are bound to have the sameeffects on growth as those in the US. Furthermore, as the headlines have shown us in the UK, Greece,and Spain, angry European youths have already decided to take to the streets on this issue.Spain: http://www.bbc.co.uk/news/world-europe-13466977Greece: http://en.wikipedia.org/wiki/2010%E2%80%932011_Greek_protestsOn top of that, the Eurozone has been revealed to be much more unstable because the crisis has madeit painfully clear that the Eurozone has no pre-set plans to deal with the financial trouble of themember-nations. This is despite the fact that monetary policy in the Eurozone is set along a strict price-stability mandate, with no pronounced growth mandate (this was already likely to result in economictroubles in both the Mediterranean rim and in Eastern Europe. My question is why did the ECB notdecide on an “Anglo-French” monetary policy, whereby both growth AND price stability are mandated?To add even more fuel to the fire, EU common market rules allowed and even encouraged cross-borderbanking, without having proper microprudential rules in place to mandate responsible and sustainableEuropean banking practices. In fact, prior to 2008, financial-regulatory regimes were different fromcountry to country across the EU, with little-to-no coordination between banking authorities in thevarious EU countries.While this is more or less a perfect recipe for financial troubles over a 10-year time-span, the EU did nothave a financial crisis mechanism. The result is: A drop in growth for the coming few years A dramatic increase in the money supply The lack of microprudential banking and financial banking regulation
In the face of all this, the response from Europe has been a bilateral response whereby Germany andFrance have decided to respond to the economic troubles in the Mediterranean rim on their own. It is asif California tried to resolve its debt crisis by asking Vermont for a loan. Does that not just seem like astupid way to do things?Some Bright Spots in EuropeSince the emergence of the financial crisis in Europe in 2008, there has been an effort to coordinateboth financial crisis response policy by founding the EFSF, as well as the EFSM and financial, banking,insurance and fiduciary regulation by means of the ESRB, EBA, and ESFS.