When it was all academic, I enjoyed reading about the causes of the Wall Street Crash, the Great Depression and the German hyper-inflation. Policy errors abounded. The UK going back on to the Gold Standard in the middle of the crisis and sending the economy down in to a deflationary spiral. Andrew Mellon, US Treasury Secretary, saying “liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate…it will purge the rottenness out of the system” (and letting the banks go bust). France demanding punitive war reparations from a desperately weak Germany, causing money printing and social unrest.
So if what we’re seeing right now is the start of a second wave of the Great Recession, what will historians think were the big policy mistakes in the couple of years since the first down-wave ended in 2009? Here are a few ideas – the 10 recent policy errors that have sent us back to the brink:
1. The ECB hiking interest rates twice this year in response to a commodity led inflation overshoot. Whilst I guess this gets reversed next month (or even sooner?) and the ECB cuts, the damage this did to confidence and to European funding costs was significant, not least because it caused the Euro to remain relatively strong. There was no evidence of second round inflationary effects, and the hikes came at a terrible time in the recovery.
2. The Tea Party and the idiots on both sides of politics in the US not coming up with even small compromises that would have given S&P an excuse not to downgrade the US from AAA.
3. The continuing Osborne UK austerity programme. As economic growth deteriorated, as youth unemployment rocketed and as confidence collapsed, he announced there was no Plan B. “Liquidate, liquidate, liquidate”, as Mr Mellon might have said, applauding.
4. Not banning shorting via sovereign CDS. We like CDS, we use CDS. But if they didn’t exist, the ECB could have aggressively bought peripheral European bonds and driven their yields down. Nowadays, whilst they were doing this in the physical bond market, the market was signalling its disbelief via wider CDS spreads. This visible secondary market doesn’t allow anyone to suspend disbelief. The price action in sovereign CDS dominates sentiment – just take a look on Twitter.
5. Over-regulation of the banking sector. I’m not sure about this one, because the banks are evil, right? But the backdrop of Dodd-Frank in the US, the global solvency regulations and Basel 3, the ring fencing of retail/investment banking etc. doesn’t provide an environment in which bank lending will aggressively recover. That’s if you think more bank lending/leverage in the system is a solution to this mess.
6. Not bailing out Greece/not letting Greece go bust quickly. It kind of didn’t matter which, but one of them could have saved the Eurozone. Greece started to wobble at the end of 2009, so we’ve had nearly 2 years of sovereign debt uncertainty now. Incidentally, could you compare the clamour for austerity for the Greeks now, to the French demands for implausible payments from Germany after the first world war?
7. Doing the wrong kind of Quantitative Easing. Operation Twist? The Fed needed to inject printed money directly into a broken housing market and underwater mortgages, boosting labour mobility and getting cash to those with a high marginal propensity to consume, rather than giving the printed money to investors in assets who didn’t do anything with it. QE needed to look a little more fiscal than monetary.
8. China’s pegging of the RMB to the US dollar, and the consequence of many other countries having a semi peg to the US dollar in order to remain competitive versus China. Currency wars. The RMB is the wrong price – it’s artificially too weak and therefore developed countries’ currencies are artificially too strong. This led to a race to the bottom to weaken relative to other economies, and that didn’t help anyone.
9. There was a brief moment in the quiet year or so that we had, when UK defined benefit pension funds were pretty much fully funded for the first time in years. They could have de-risked and locked in benefits for their members. Now that equity markets are nearly 20% lower, and bond yields have fallen by 1.5% (meaning assets have fallen, and liabilities risen) that’s no longer the case. Pension funds didn’t de-risk in the good times, and left millions of workers and pensioners in peril for the future.
10. Not enough shock and awe. Policy was always too incremental. The world economy needed huge injections of monetary stimulus and fiscal stimulus. The policy announcements were never enough, and confidence in policy making itself faded away as time went on. Obama would like to extend a tax cut, the Fed will do something to do with the shape of the yield curve, the ECB will buy a few Portuguese bonds, the Bank of England might print £50 billion more. The policy action was too tentative – and there wasn’t enough collaboration between policy-makers across the world.
I’m sure you’ll disagree, or have other policy errors to add. If so, you can comment below, or tweet me @bondvigilantes.