Shadow Government

Who spooked the markets?

As global stock markets tumbled over the last few trading days, pundits fell all over each other to assign blame. Not only can the finger-pointing be diverting — and perhaps politically advantageous — but it is natural to search for reason and understanding in such a harrowing time. The problem is a surfeit of suspects. ...

STAN HONDA/AFP/Getty Images
STAN HONDA/AFP/Getty Images

As global stock markets tumbled over the last few trading days, pundits fell all over each other to assign blame. Not only can the finger-pointing be diverting — and perhaps politically advantageous — but it is natural to search for reason and understanding in such a harrowing time. The problem is a surfeit of suspects. Here are a few:

Was it the S&P downgrade?
On Friday, after markets closed, the United States lost its AAA rating, at least in the eyes of one beholder (and not the first). It was a clumsy process, marred by math errors, that seemed to reinforce a lingering low opinion of the ratings agencies left over from their gullible endorsement of subprime mortgage bundles.

At the heart of S&P’s critique was a pessimism about the U.S. political process. There are two facets to this: the dalliance with default in the debt ceiling debate, and concerns about the longer-term fiscal situation in the country.

There are a few problems with fingering the S&P as the reason for the market swoon. First, U.S. markets fell for a couple days preceding the downgrade. Second, the existence of U.S. political dysfunction was hardly news. Third, and most telling, the wrong markets fell on Monday. If the driving concern is that the U.S. government will be unable to pay its debts, one would expect the price of those debts to fall. Instead, it was stocks that fell while U.S. bond markets rose sharply. The 10-year bond yield, which had been 3.2 percent in the start of July, fell to 2.34 percent yesterday (bond yields move in the opposite direction from bond prices). Such a drop can signal a number of ominous things, but not generally doubts about the lender’s creditworthiness.

Was it President Obama’s Monday afternoon speech?
The talk, which notably failed to calm markets and drew scathing reviews, did not offer any new or promising vision. Yet despite the fact that the Dow dropped a couple hundred points after the President spoke, this explanation seems as implausible as the popular argument that it was all Republicans’ fault. To spell that latter argument out: House Republicans supported fiscal responsibility (passed a budget) and opposed tax hikes. They used their constitutional power over the budget and borrowing to win a deal that would begin to impose some spending restraint and that precluded any similar default standoff for the rest of the President’s term. Markets, the reasoning must go, hated all that. The standoff went on for weeks, but somehow markets only reacted once Standard & Poor’s explained it all to them, days after it was resolved.

On to the next suspect.

Was it the bad news about the American economy?
The last couple of weeks have featured some weak readings on the U.S. economy, including surprisingly poor GDP numbers on July 29. The jobs number last Friday was strong enough to stave off utter despair, but too feeble to portend a reviving economy. What’s more, lest anyone forget the lingering effects of last decade’s housing boom and bust, Monday featured a stark reminder. AIG filed suit against Bank of America alleging mortgage securities fraud. BofA’s stock dropped 20 percent for the day.

The eminent Ken Rogoff provides a thoughtful, if disturbing, overview of the economic scene in today’s Financial Times. He argues that large debt overhangs are not very amenable to quick fixes, like fiscal stimulus, and suggests:

"It is better to think of the global economy as going through a ‘Second Great Contraction’ (the Great Depression being the first) involving credit and housing, and not just output and unemployment."

Was it the festering crisis in Europe?
In the Washington Post, Robert Samuelson makes a case that the real troubles lie across the Atlantic. He opens:

Europe may no longer be able to save itself. Too many countries have too much debt. Its economic growth — which helps countries service their debts – is too feeble. And nervous financial markets seem increasingly prone to dump the bonds of vulnerable countries. This is the real risk to the global and U.S. economic recoveries, far overshadowing Standard & Poor’s downgrade of U.S. Treasury debt and Monday’s sharp stock market decline."

I discussed some of the foreign policy implications of a European breakdown back in June. These are secondary to the direct economic ramifications. A crisis revolving around debt and Europe’s common currency would pose existential problems for the European Union, would cripple a major world economy, and could jolt the U.S. financial sector.

Fortunately — or unfortunately — we don’t need to pick just one culprit for recent financial swoons. As strong as the temptation may be to anthropomorphize The Market, it really is a collection of millions of people placing buy and sell orders for their own, potentially diverse, reasons.

If we give up on explaining each jag of the Dow Jones and instead look at the economic landscape, there is one useful distinction to be drawn. With some problems, one can discern solutions; the question is whether there will be the political will and leadership to reach those solutions. The U.S. difficulties fall in this category. The Bowles-Simpson deficit reduction commission offered one viable fiscal path; House Republicans offered another, in the form of a budget. President Obama may offer a third. With other problems, it is hard to see any palatable solution. Each potential outcome is tainted by alarming risks. Europe’s situation falls in this category. With both these types of economic problem roaming the land, small wonder markets got spooked.

Phil Levy is Senior Fellow on the Global Economy, The Chicago Council on Global Affairs, and teaches strategy at Northwestern University’s Kellogg Schoool of Management.

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