Chandler: Policy makers are repeating the mistakes of the 1930s


Marc Chandler, Global Head of Currency Strategy at Brown Brothers Harriman has an alarming note out this morning on economic policy.  I take notice because Chandler usually writes in more nuanced and non-apocalyptic tones.  For example, he begins:

The risks are asymmetrical.  Many of the world’s national economies, in various stages of recovery, are still highly dependent on government support.   While it is possible that the combination of aggressive fiscal and monetary policy responses have put the economies on a strong growth path, there remains a much greater risk that as the stimulus is removed the economies stagnate or worse.   

Aborted recoveries are rare.  They are the exception that proves the rule.  Despite the gallons of ink spilled on prognostications of a “double dip” or a “W” shaped bottom, there have only been two in the U.S.—the Great Depression and the early-1980s Reagan-Volcker recession.  They seem to be products of a policy error, like removing a splint too early from a broken bone.

However, his latest thematic piece changes course abruptly when he writes:

Nearly all policy makers share two key interests: lay the foundations for a sustainable economic recovery and unwind the emergency facilities and spending.  There appeared to have been a consensus, giving more weight to the former than the latter this year.  The bond vigilantes have instigated a disruption of that consensus much to the chagrin of the popular will.  Indeed, those countries that capitulate the most to the vigilantes are likely to experience the most social push back.    Stay tuned. 

Ironically, the effect of the bond vigilantes and the social resistance may be similar insofar as the economic impact is negative.  Ultimately what is at stake is the how the costs (broadly understood) of the bailouts and stimulus are going to be distributed, not just in terms of classes, but also sectors, industries and countries.     

This is taking place along another potent but yet somewhat less personal of a force.  Like a victim in a trendy vampire show, the life blood of the two largest economic regions, the US and Europe, is being sucked out. 

Money supply, measured by the ECB’s M3 has collapsed.  In January 2009 it was growing at a 6% year-over-year pace.  By the end of the year it was contracting at a 0.2% pace.  It was contracting in both November and December.  The next report is due January 25th and even if one is not a monetarist, the situation is worrisome. 

It has been lost in the light of the preliminary 5.7% Q1 US GDP, but in the Fed’s statement there appeared what seems like the first official recognition of the ongoing contraction in bank credit.  The FOMC implies that this is being offset by improved financial market conditions.  We thought so too. 

But the capital markets are fickle and given the surge in volatility and the general deterioration of market conditions (should it persist), the risk is that it no longer is sufficient to offset the contraction in bank credit.   Even if this is just a normal market correction, it could stall the economies at a crucial time.

The real tragedy is not what is happening in Athens, as painful as the adjustment promises to be.   Rather the real Greek tragedy is that we are running quickly, even if not irrevocably yet, into precisely that which we wanted to avoid the most. [emphasis added]

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The takeaway here is that we are still in a credit crisis. What is happening in the sovereign debt markets is going to force policy makers to unwind stimulus and accommodation sooner than later. However, doing so risks disaster because signs of recovery are still quite incomplete at this juncture. The evidence comes in both the Fed’s assessment of low credit demand and the ECB’s assessment of outright monetary contraction.  You don’t get sustainable GDP growth in a world of contracting monetary aggregates and sluggish credit demand.

The explosive undercurrent of Marc’s comments come where he mentions ‘”how bailouts and stimulus are going to be distributed.” What he seems to suggest is that a premature policy exit puts would put most of the risk burden on specific classes, economic sectors and countries (think: high school graduates, homebuilding, industrial commodities and Spain for example).

This does not seem like a logical outcome given comments from people like Ben Bernanke that we have learned from the Great Depression and now know what needs to be done in a severe financial crisis. But, for now, this is where we’re headed.

Read Chandler’s full piece at BBH’s FX website linked below.


Amor Fati: Moving toward Our Maximum Regret (pdf) – Marc Chandler, BBH Thematic Piece, 05 Feb 2010

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