Dubious downgrade has consequences: Balance sheet recession requires fiscal stimulus and monetary accomodation

Crises always teach participants important lessons. The key lesson from this avoidable crisis in the stock market is the urgent need to reform the rating agencies to ensure they actually understand something about the modern global economy and the history of financial crises and the appropriate response to them. Clearly Standard and Poor does not understand this.

The appropriate response was made clear during the great depression of the 1930s and it is crystal clear today. The G7 countries, the European union and their allies in Asia and Latin America need to understand that the correct policy is massive spending by governments to stimulate their economies, an increase in deficits as investments directed at employing people and supported by extremely low interest rates . This needs to be a much larger program than the one that was just conducted and it needs not to be undermined by cut backs at the state and local level. The large cash reserves from profits that are now parked at banks and in treasuries can thereby be productively put to use.

There are increasing numbers of economists who understand this although they may disagree about some of the details of the strategy. These include people like Richard Koo in Japan, Paul Krugman in the U.S., Joseph Stiglitz in the U.S.,Brad Delong in the U.S. Mario Seccareccia in Canada, Marc Lavoie in Canada,Peter Dimand  in Canada, Robert Skidelsky in the U.K, the various post Keynesians and Keynesians  in Britain including Sheila Dow, Tony  Thirlwall, Victoria Chick, Philip Arestis, Malcolm Sawyer, Peter Clarke and a number of other economists of similar persuasion in the  U.S., Australia, Japan and Canada. So far this morning (2:31 a.m. Montreal time) the stock markets in Asia are falling and futures suggest they will fall in Europe and New York.

But as direct evidence of how wrong S&P has been the demand for U.S. treasuries continues to be strong and their price has been rising and yields falling as investors flee equities to the security and reliability of U.S. treasuries. We shall see where this goes later today but the turmoil was unnecessary and damaging and its long overdue that some new thinking informed by a knowledge of history carries the day in economic policy.

Update: 12:36 p.m. Montreal time the Dow Jones industrial average is now down 324 points. 1:48 p.m. down 428 points.2:09 p.m. down 430.Down at close 634.

9:28 pm Montreal time, the sell off continues in Asia with markets down from 2.7 % to 6.3 %. One positive development is that the fall in commodity prices also includes a fall in oil prices to below $80 a barrel. Inflation clearly continues not to be a problem, except perhaps in China.

Tuesday update: the markets once again revealed their tendency to wildly fluctuate by bouncing back strongly in New York by about  430 points as low prices drew bargain hunters back in and the Fed reassured markets that interest rates would be kept very close to zero for the next two years until the economy is much stronger (and the 2012 election is out of the way). As usual markets are very irrational and bi-polar so we shall see what happens tomorrow.The rally may be a one day wonder but it may well continue to recover somewhat from the oversold position it reached on Monday. So far so good as they are also up in Asia following the good news in the U.S. Joseph Stiglitz has a good piece in the FT on the need for stimulus but is pessimistic on overcoming the gridlock in Washington politics. I am not so sure. I posted a comment which I will add to the blog a little later.

Wednesday update: Markets are down again by over 350 points in N.Y. The instability and bearish trend continues. Below is a link to Stiglitz’s article in the FT and if you scroll through the comments you will find mine  at Aug.10 @ 2:52 a.m.

http://www.ft.com/cms/s/0/c864cd58-c1d1-11e0-bc71-00144feabdc0.html#ixzz1UddyzAu4

Wednesday 6:27 pm update The Dow closed down 519 points wiping out the rebound of Tuesday. The stock market is now down by about 20 % from its  recent peak in April. today. The  downturn was linked by analysts to the banking ”crisis” in France.

Thursday morning Wall street futures moderately up suggesting a small rebound may occur.

Check out Robert Reich’s blog post http://www.robertreich.org where he argues for a major stimulus to be adopted by the Democrats as their policy thrust, despite the Republican opposition to this. We agree.

Thursday 12:43 the market in New York is now up by 278 points and is just shy of 11,000 on the Dow. Good news on Cisco profits and payroll numbers that beat expectations have along with contrarian bargain hunters have helped push the market part way back up the hill for the time being.    1:06 p.m. up 360 to 11100.

In France President Sarkozy is unwisely calling for further budget cuts in response to the pressure of the speculators who are buying credit default swaps on French debt which is nowhere near a place of crisis since the gross debt to GDP ratio is 81.7 % understandable since the unemployment is still 9.7% and the French like other leading European countries suffered some damage during the crash and crisis of 2008. Banning naked short selling may help.

Friday noon: Dow up again to 11,282 ,139.7 and 1.25 % on top of the 400 plus point rise at close yesterday. Program trades, bargain hunting and perhaps short selling ban in Europe have aided in regaining some of the lost ground. Have a look at the Nouriel Roubini interview in the Wall Street Journal. Very pessimistic, perhaps unduly so and provocative. But he is definitely correct in arguing that long run excessive inequality is societally  unsustainable and economically damaging.

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About haroldchorneyeconomist

I am Professor of political economy at Concordia university in Montréal, Québec, Canada. I received my B.A.Hons (econ.&poli sci) from the University of Manitoba. I also completed my M.A. degree in economics there. Went on to spend two years at the London School of Economics as a Ph.D. student in economics and then completed my Ph.D. in political economy at the University of Toronto. Was named a John W.Dafoe fellow, a CMHC fellow and a Canada Council fellow. I also was named a Woodrow Wilson fellow in 1968 after completing my first class honours undergraduate degree. Worked as an economist in the area of education, labour economics and as the senior economist with the Manitoba Housing and Renewal Corporation for the Government of Manitoba from 1972 to 1978. I also have worked as an economic consultant for MDT socio-economic consultants and have been consulted on urban planning, health policy, linguistic duality and public sector finance questions by the governments of Manitoba, Saskatchewan,the cities of Regina and Saskatoon, Ontario and the Federal government of Canada. I have also been consulted by senior leaders of the British Labour party, MPs from the Progressive Conservative party, the Liberal party and the New Democrats on economic policy questions. Members of the Government of France under the Presidency of Francois Mitterand discussed my work on public sector deficits. I have also run for elected office at the municipal level. I first began to write about quantitative easing as a useful policy option during the early 1980s.
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