Earlier this year, I had booked up quite a bit of leave for this summer, both for genuine holidays and other unavoidable commitments. I had hoped that, with the July euro area summit out of the way, markets would quieten down a bit over August and I would have some time to catch up when I got back into the office.
Needless to say, things have turned out rather differently. The US debt deal and downgrade, renewed euro area fears and ECB purchases, stock market losses and volatility, and the riots in the UK, meant that my inbox was even more clogged than usual when I finally got back to work this week. And unlike previous summers, where the ‘silly season’ has produced all sorts of weird outcomes that have little implication come the fall, the past few weeks could have a big impact on the world and UK economic recoveries.
At first sight, the US debt downgrade by S&P looks like the least important. US Treasuries took the news firmly in their stride, and with benchmark 10Y yields trading at around 2Â¼% today, the downgrade has had more of a political than an economic impact. But with the economy showing real signs of weakness in the latest GDP and nonfarm payroll data, the debt deal between the Republicans and the Democrats looks increasingly daft. Forcing cuts in the short term, but at the same time not addressing the deficit over the medium to longer term, is almost exactly the wrong way around. Instead, policymakers should be shoring up growth in the short term, but setting out long-term plans for deficit reduction. With the Fed uneasy about a third bout of quantitative easing, amidst continued doubts about its impact, the largest economy in the world is struggling.
Things aren’t exactly much brighter on the other side of the Atlantic. While the euro area economy as a whole managed to grow by 0.2%Q/Q in the second quarter, that was down markedly from the +0.8% reading in Q1. Even worse, Germany and France, the two largest economies that had been driving the recovery, basically came to a standstill. With the ECB having been forced to step in to buy Spanish and Italian debt – at last, fulfilling its role as the ultimate guardian of the euro – euro area politicians are increasingly realising that either they have to opt for some closer form of fiscal union, or they will have to manage the fallout from a sovereign default. For my money, it still looks unlikely that anyone will leave the currency union – and Germany’s exit is still the only serious way the euro will break up – but in the absence of Eurobonds default is looming ever larger on the horizon.
In the UK, meanwhile, the current debate is over what started the riots that led to such widespread damage and looting. I was in Italy in the aftermath of the riots, and it was the main topic of conversation with just about every person I spoke to, be they Italian, Austrian, French, German or British. The riots have clearly damaged the UK’s international standing. And while the current dearth of opportunities and jobs has clearly amplified dissatisfaction with the status quo, personally I do think a lack of boundaries played a major role in fostering the destruction. Politicians now face the twin challenges of keeping the UK economy afloat while its major trading partners teeter dangerously close to the edge, at the same time as trying to understand and repair the damage to British society. Neither issue is going to go away any time soon: MPs need to be in this for the long haul.
All in all, I would definitely rather still be on holiday.