Making resolutions to improve one’s personal and professional life is a common occurrence at New Year’s, but what about for financial markets? Although I have tried, I have yet to be able to find a personal resolution that will reduce global market volatility.
Given that macro-economic events seemed to be among the main drivers of market behaviour in 2011, there are three parties who could accomplish this feat: U.S. politicians, the eurozone governments and China. The question remains as to whether the political will exists. China is the wildcard and as such I will spend most of the article looking specifically at what I would suggest China’s resolution should be.
U.S. federal politicians need to make a resolution to come up with a multi-year deficit-reduction plan that is credible to financial markets and investors. The current deadlock is not based on whether the deficit needs to be reduced—on that point there is full agreement. Where the politicians don’t agree is the relative contributions of spending cuts and revenue enhancements.
One side has the view that revenue enhancements must play a significant role, while the other insists that spending cuts be the main instrument. Short of a New Year’s resolution miracle, what seems most likely is that the politicians will continue to fight over how to reduce the federal government deficit for much of 2012. The ideological divide might get resolved in the November elections. Or it might not, in which case either a big push from capital markets or an unlikely dose of common sense among politicians will be necessary to find a solution.
For the political leaders of Western Europe, particularly those in the eurozone, a resolution to speed up their decision making process would be welcome. In fairness, and unlike the constant deadlock over U.S. fiscal policy, European political leaders have actually been trying—admittedly pushed by very unhappy bond markets—to come up with a solution. One could argue that each successive attempt—there have been five high-level summits focused on the problem—has been more productive than the last.
The most recent proposals, based on more centralized fiscal policy—appear to be on the right track. But, partly because there are so many parts to the puzzle, the solutions that have been proposed are of the slow, ‘grind-it-out’ variety. What has dismayed capital markets is that there hasn’t been a catch-all solution—such as the issuance of euro-bonds and/or the designation of the European Central Bank as a lender of last resort for the eurozone.
The process thus far has been a text book case of the difference between market speed, where decisions are made in seconds, and government speed, where the need for consultation and consensus stretches much decision-making into weeks and months.
European leaders must resolve to get up to market speed by devising solutions that are politically palatable which would also sooth the fears of financial markets. The benefits, such as lower yields on the bonds of countries in difficulty, would be worth the cost and effort.