Draghi's Debut - Mazars - Ireland

Mario Draghi kicked off his presidency of the ECB off to a shock-surprise start with his cut of 0.25 per cent in the interest rate. Already the commentators are calling him Super Mario! The rate cut announced today was not flagged but nonetheless not surprising.

His inaugural was entirely overshadowed by events elsewhere and global and most critically, an EU and euro on verge of collapse. For all of the leaders and their advisors in Cannes for the G20, for the ECB itself, for the Fed and for commercial bankers and political leaders almost everywhere it has been a dreadful few weeks, relentlessly – if also predictably so. Mr Papandreou’s decision was a surprise of bunker buster proportions but it was already well clear that the Greek workout was not working out, had not from the beginning. To the IMF at least it was clear that the troika of which it is a member had not achieved much in its 18 month engagement in Greece. So it is return to go, with a big new bail-out budget and the need also to undertake substantial repairs to a seriously damaged economy and society – and a huge crisis politically.

It is not simply Greece however.  Economic policy in Europe more generally is in the grip of ‘austerity’ although the word ‘growth’ is beginning to creep into conversation – and not as a dirty word. The US also remains paralysed by an intentionally Republican onslaught on the White House and all it currently stands for. Germany and France are both stalled as is Italy and in reality the UK despite relief at its recent Q3 GDP figure (which was a first estimate). The eurozone as a whole is mired in a recession inducing austerity rule and the forecasts currently being made for 2012 are bad, very bad. Truth to tell the quality generally of economic public policy-making has not impressed.

Figure 1

Figure 2

Figures 1 and 2 show how only back in September the IMF was modelling the next few years: broadly, booming BRICS on the growth and unemployment fronts and lagging developed world with US and EU broadly telling the same story. Today though – even a matter of weeks only – it has all got a lot worse. On 2 November the Fed held US interest rates and revised their forecasts for US: projected growth for this year (modest to start with), slashed from June figure; forecast annual growth out to 2013 slashed from June figure. On unemployment, projection for this year hiked from June and annual rates to 2013 similarly raised. The developed world generally is on the verge of recession and some countries and regions are already arrived there. From this starting point of course everything into the future has to be downgraded and big downsides emphasised. Gloomy though the forecasts were three months ago they saw sunny uplands compared to today’s prospects of severe slowdown in the developed economies with huge downside risks of things getting seriously worse.

Figure 3
Figure 3 shows one view of what lies beneath. What production managers are up to and what they see is a portent – thus the import of production manager indices (PMIs).  JP Morgan?Markit’s latest global PMI shows a not pretty picture – hovering on the 50 per cent border between expansion and contraction but heading south of the 50 per cent.

Behind these macro statistics and forecasts there are the actions of economic agents: governments, corporate, households etc. In the entrails at this level we see public authorities in a Gadarene rush to premature fiscal tightening and PMIs – forward or leading indicators – all heading in the wrong direction. We see unemployment (a lagging indicator) still rising or at best sticky at high levels. We see corporate balance sheets either deleveraging or by now very well resourced but managements individually sensibly intent on investment inaction (the liquidity trap). We see households continuing to deleverage and in negative equity. Consumer prices are either rising and squeezing households further or falling as retailers scramble for any last sale regardless of margin. We see financial markets chasing the impossible – high yielding risk-free havens! And we see macro authorities pursuing their own chimeras – external surpluses for all (??) – and simultaneously hard currencies (low inflation) and soft currencies (export sales).

All of this reflects the fundamental point, to which many commentaries have repeatedly pointed: this is a balance sheet recession triggered by a property bubble and leaving banking shattered – it is Japan in the 1990s. Further in the last decades the financial sector (Finance, Insurance and Real Estate or the ‘FIRE economy’) has become so central and essential to the wider economy that a wrecked banking system significantly complicates the pursuit of recovery and a return to growth. Banking policy, regulation and supervision need radically to be overhauled as well as literally building a new financial system, one that is safe to fail.

More than such engineering though central to any new system has to be the visionary abandonment of the obeisance we currently pay to the creditors as conveyed by Martin Wolf’s quotes above and below. Central therefore must be a wish to build on Wolf’s proposition.

Do creditors rule the world? Not really. In the short run, they can threaten to turn off the credit. But their surpluses depend on the willingness and ability of others to run deficits. It would be more sensible to admit that there has been too much borrowing by the profligate because there was too much lending by the supposedly prudent. Once it is understood that both are at fault, both must adjust. Imposing one-sided adjustment on erstwhile debtors will not work. As little Greece seems about to prove, debtors are able to inflict a great deal of damage on everybody – as the US discovered in the Great Depression. It would be a good idea to rediscover that reciprocal interest urgently, right now. Creditors do not sell to Mars. We are all on the same planet. Agree to fix its messes, right now.  

Can governments listen to and act upon this analysis? If not we are facing a very different world and in the short to medium term at least, not a better one. And will Mr Draghi follow up in December with a present? Answering Ralph Atkins of the FT at his press conference, "We never pre-commit." Maybe, but there might be something to anticipate with some confidence.

3rd November 2011