Two years ago, it became clear that resolving the crisis would require two key rebalancing acts—a domestic demand switch from the public to the private sector, and a global demand switch from external deficit to external surplus counties… the actual progress on rebalancing has been timid at best, while the downside risks to the global economy are increasing…
I would like to delve deeper into the different problems of Europe and the United States.
I’ll start with Europe…
Banks need urgent recapitalization. They must be strong enough to withstand the risks of sovereigns and weak growth. This is key to cutting the chains of contagion. If it is not addressed, we could easily see the further spread of economic weakness to core countries, or even a debilitating liquidity crisis. The most efficient solution would be mandatory substantial recapitalization—seeking private resources first, but using public funds if necessary. One option would be to mobilize EFSF or other European-wide funding to recapitalize banks directly, which would avoid placing even greater burdens on vulnerable sovereigns…
The United States needs to move on two specific fronts.
First—the nexus of fiscal consolidation and growth. At first blush, these challenges seem contradictory. But they are actually mutually reinforcing. Credible decisions on future consolidation—involving both revenue and expenditure—create space for policies that support growth and jobs today. At the same time, growth is necessary for fiscal credibility—after all, who will believe that commitments to cut spending can survive a lengthy stagnation with prolonged high unemployment and social dissatisfaction?
Second—halting the downward spiral of foreclosures, falling house prices and deteriorating household spending. This could involve more aggressive principal reduction programs for homeowners, stronger intervention by the government housing finance agencies, or steps to help homeowners take advantage of the low interest rate environment.
Sobering stuff, and shockingly frank talk from a central banker.
And yet today, the markets are up, way up (on very little volume, which is rather suspect). The common wisdom is because consumer spending reported an increase, hooray! You can't keep the American consumer down. Or can you? Digging into the numbers reveals some subtleties. From a post on Zero Hedge: Personal Saving Rate Plunges From 5.5% To 5.0% As July Energy Expenditures Soar
July personal income and expenditures were quite surprising in that while many were expecting the drop in the market to force consumer saving to upshift (lower spending than income), not only was this not true, but expenditures spiked by 1 whole percent from -0.2% to 0.8%, on expectations of 0.5%, even as Personal Income came in line with expectations of 0.3%, up from a revised 0.2% (concurrent with extensive prior data revisions). This was the biggest difference between a monthly change in income and spending since October 209. The net result was a plunge in the savings rate from 5.5% to 5.0%. And while on the surface this would be good news, as in Americans are spending again, a quick look at the PCE components indicates that virtually the entire surge is due to a spike in Energy goods and services. In other words, the entire spike in spending was to... pay for gas and associated energy expenses. Which makes sense: in June this was a drop of -4.5%, it is only logical that the subsequent jump in Brent and WTI forced American savings to drop. All in all: in July Americans continued to max out their credit cards to pay for gas. As for the income side, transfer payments as a % of spending refuse to budge: thank you Uncle Sam.
If you've read Bernanke's speech from 2002, you'll know this is exactly what he had in mind when he said the Fed has the power to increase nominal spending by injection of liquidity (QE). But is this a real increase in aggregate demand that is required to support a real recovery? I don't see how these dots connect. Without the latter, it is just another transfer of wealth from have-nots trying to make ends meet to haves with speculative free credit to play with and drive up commodity prices.
The central banks and governments are all-in on the idea that the existing financial system can be kept from falling in a deflationary spiral "just long enough" for households to start spending again. Consumer confidence is key and the political and economic situation does not appear rosy for the average citizen. If more people decide to save instead of spend, it will be a "disaster" for the existing system.
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