THE RECENT volatility in financial markets – with large falls in stock prices in the US and Europe – reflects both a failure of political leadership on both continents and a deterioration in the outlook for economic growth. Not surprisingly both these factors have taken their toll on investor sentiment.
Lack of investor confidence in a deteriorating world economy and in the ability of political leaders to tackle major economic issues helps to explain the recent major sell off in equities and the sharp rise in the price of gold.
One reason why credit ratings agency Standard & Poor’s downgraded US debt was the political brinkmanship and tardiness displayed by Democrats and Republicans in raising the debt ceiling and in reducing the federal deficit. Political leaders in Europe have shown a similar reluctance to make tough choices, delaying too long and doing too little to address the euro crisis. Bold political leadership is required to tackle a global economic problem – low growth and high levels of sovereign and private debt – but political leaders seem more inclined to follow public opinion than to lead it.
Tuesday’s decision by the US Federal Reserve to hold short-term interest rates at the current low level for two years was welcomed by financial markets, providing some reassurance and certainty. That decision increases the likelihood of a third round of quantitative easing – the government printing money – in an effort to boost growth in an economy that has stalled and that now risks slipping back into recession. Such a move may well be needed, given the limited scope for further interest rate cuts or a fiscal stimulus.
Jean-Claude Trichet, head of the European Central Bank (ECB) underlined the scale of the challenge that Europe faces in remarks on French radio this week. Financial markets, he said, were facing “the worst crisis since World War II and it could have been the worst crisis since World War I if leaders hadn’t taken the important decisions”. This was a reference to the ECB’s reluctant purchase of Italian and Spanish debt, an action that pushed the cost of borrowing for both countries down to sustainable levels, ensuring that both can, for now, avoid a bailout. But Mr Trichet again suggested it was time for euro zone member states to take greater responsibility for the euro crisis.
Euro zone leaders last month agreed to strengthen the European Financial Stability Facility (EFSF), enabling it to buy bonds on the secondary market with the aim of stabilising bond prices. While the change awaits approval by national parliaments, the ECB is temporarily performing that role. Otmar Issing, a former ECB executive board member, has suggested that what many see as a step to political union – a European bond with debt issued and guaranteed centrally – will “end up dividing Europe”. It would mean, he predicts, higher borrowing costs for fiscally solid countries like Germany while more reckless countries could borrow at lower rates than before. His critique of the euro project indicates the scale of the challenge now facing Europe’s political leaders, not least Germany’s Angela Merkel.