The debts of many countries in the eurozone are becoming increasingly difficult to service. With negative growth in some countries (Greece’s GDP is set to decline by over 5% this year) and falling growth rates in others, the outlook is becoming worse: tax revenues are likely to fall and benefit payments are likely to increase as automatic fiscal stabilisers take effect. In the light of these difficulties, market rates of interest on sovereign debt in these countries have been increasing.
Talk of default has got louder. If Greece cannot service its public-sector debt, currently standing at around 150% of GDP (way above the 60% ceiling set in the Stability and Growth Pact), then simply lending it more will merely delay the problem. Ultimately, if it cannot grow its way out of the debt, then either it must receive a fiscal transfer from the rest of the eurozone, or part of its debts must be cancelled or radically rescheduled.
But Greece is a small country, and relative to the size of the whole eurozone’s GDP, its debt is tiny. Italy is another matter. It’s public-sector debt to GDP ratio, at around 120% is lower than Greece’s, but the level of debt is much higher: $2 trillion compared with Greece’s $480 billion. Increasingly banks are becoming worried about their exposure to Italian debt – both public- and private-sector debt.
As we saw in the news item “The brutal face of supply and demand”, stock markets have been plummeting because of the growing fears about debts in the eurozone. And these fears have been particularly focused on banks with high levels of exposure to these debts. French banks are particularly vulnerable. Indeed, Credit Agricole and Société Générale, France’s second and third largest banks, had their creidit ratings cut by Moody’s rating agency. They have both seen their share prices fall dramatically this year: 46% and 55% respectively.
Central banks have been becoming increasingly concerned that the sovereign debt crisis in various eurozone countries will turn into a new banking crisis. In an attempt to calm markets and help ease the problem for banks, five central banks – the Federal Reserve, the ECB, the Bank of England, the Bank of Japan and the Swiss National Bank – announced on 15 September that they would co-operate to offer three-month US dollar loans to commercial banks. They would provide as much liquidity as was necessary to ease any funding difficulties.
The effect of this action calmed the markets and share prices in Europe and around the world rose substantially. But was this enough to stave off a new banking crisis? And did it do anything to ease the sovereign debt crisis and the problems of the eurozone? The following articles explore these questions.
Articles
Central banks expand dollar operations Reuters, Sakari Suoninen and Marc Jones (15/9/11)
Europe’s debt crisis prompts central banks to provide dollar liquidity Guardian, Larry Elliott and Dominic Rushe (15/9/11)
From euro zone to battle zone Sydney Morning Herald, Michael Evans (17/9/11)
Global shares rise on central banks’ loan move BBC News (16/9/11)
Geithner warns EU against infighting over Greece BBC News (16/9/11)
How The European Debt Crisis Could Spread npr (USA), Marilyn Geewax (15/9/11)
No Marshall Plan for Europe National Post (Canada) (16/9/11)
Central banks act to help Europe lenders Financial Times, Ralph Atkins, Richard Milne and Alex Barker (15/9/11)
Central Banks Seeking Quick Fix Push Dollar Cost to August Lows Bloomberg Businesweek, John Glover and Ben Martin (15/9/11)
Central banks act to provide euro zone dollar liquidity Irish Times (15/9/11)
Central banks pump money into market: what the analysts say The Telegraph (15/9/11)
Central banks and the ‘spirit of 2008’ BBC News, Stephanie Flanders (15/9/11)
Central Bank statements
News Release: Additional US dollar liquidity-providing operations over year-end Bank of England (15/9/11)
Press Release: ECB announces additional US dollar liquidity-providing operations over year-end ECB (15/9/11)
Additional schedule for U.S. Dollar Funds-Supplying Operations Bank of Japan (15/9/11)
Central banks to extend provision of US dollar liquidity Swiss National Bank (15/9/11)
Questions
- Explain what is meant by debt servicing.
- How may the concerted actions of the five central banks help the banking sector?
- Distinguish between liquidity and capital. Is supplying extra liquidity a suitable means of coping with the difficulties of countries in servicing their debts?
- If Greece cannot service its debts, what options are open to (a) Greece itself; (b) international institutions and governments?
- In what ways are the eurozone countries collectively in a better economic and financial state than the USA?
- Is the best solution to the eurozone crisis to achieve greater fiscal harmonisation?
- What are the weaknesses of the European Financial Stability Facility (EFSF) as currently constituted? Should it be turned into a bank or special credit institution taking the role of a ‘European Monetary Fund’?
- Should countries in the eurozone be able to issue eurobonds?
Stock markets have been plummeting. The FTSE 100 index was 6055 on 7 July 2011; by 10 August, it was 17% lower at 5007. Since then it has risen as high as 5418, but by 13 September was down to 5092. Other stock markets have fared worse. The French index fell 30% between early July and September 13, and the German DAX index fell 32% over the same period.
These falls in share prices reflect demand and supply. Investors are worried about the future of the eurozone and the health of the European economy as Greek default looks more and more likely and as the debts of various other European countries, such as Portugal, Ireland and Spain, seem increasingly unsustainable in an environment of sluggish economic growth. They are also worried about high public-sector debt in the USA and the likelihood that global recovery will peter out.
The ‘bear’ market (falling share prices) reflects increased selling of shares and a lack of demand. Not only are investors worried about the global economy, they are also speculating that share prices will fall further, thereby compounding the falls (at least until the ‘bottom’ is reached).
But why have share prices fallen quite so much? And does it matter to the general public that this is happening? The following articles seek to answer these questions.
Articles
Shares tumble on fears over Greek default Guardian, Graeme Wearden (12/9/11)
European Factors-Shares set for steep fall on Greece worries Reuters (12/9/11)
Markets set for turmoil after G-7 letdown BusinessDay (South Africa), Mariam Isa (12/9/11)
What will happen if Greece defaults? The Conversation (Australia), Sam Wylie (12/9/11)
Germany and Greece flirt with mutual assured destruction The Telegraph, Ambrose Evans-Pritchard (11/9/11)
Market Swings Are Becoming New Standard New York Times, Louise Story and Graham Bowley (11/9/11)
The next bull market The Bull (Australia) (12/9/11)
Prepare For Recession And Bear Market Forbes, Sy Harding (9/9/11)
Eurozone crisis: What market turmoil means for you BBC News, Kevin Peachey (8/9/11)
Stock market indices
FTSE 100: historical prices, 1984 to current day Yahoo Finance
Dow Jones Industrial Average: historical prices, 1928 to current day Yahoo Finance
Nikkei 225 (Japan): historical prices, 1984 to current day Yahoo Finance
DAX (Germany): historical prices, 1990 to current day Yahoo Finance
CAC 40 (France): historical prices, 1990 to current day Yahoo Finance
Hang Seng (Hong Kong): historical prices, 1986 to current day Yahoo Finance
SSE Composite (China: Shanghai): historical prices, 2000 to current day Yahoo Finance
BSE Sensex (India): historical prices, 1997 to current day Yahoo Finance
Stock markets BBC
Questions
- What factors have led to the recent falls in stock market prices? Explain just why these factors have contributed to the falls.
- What is likely to happen to stock market prices in the coming weeks? Why is it difficult to predict this?
- What is meant by the efficient capital markets hypothesis? If markets were perfectly efficient, why would it be impossible to predict future movements in stock market prices? Why may stock markets not be perfectly efficient?
- What factors determine stock market prices over the longer term?
- How are share prices influenced by speculation? Distinguish between stabilising and destabilising speculation.
- Explain the various ways in which members of the general public can be affected by share price falls. Are you affected in any way? Explain.
- If Greece defaults, what will determine the resulting effect on stock markets?
- To what extent does the stock market demonstrate the ‘brutal face of supply and demand’?
Over recent years, labour markets have become more flexible. Both firms and workers have been much more adaptable to changing market conditions.
This has been illustrated by responses to the 2008/9 recession and the minimal recovery since then. Many firms have seen a drop in demand for their products and have responded by producing less. But this has not necessarily meant laying off workers. But why not? The following include some of the reasons:
• greater flexibility in hours worked: thus hours can be reduced;
• reduction in real wages because of wages not keeping up with inflation;
• many workers receiving part of their income in the form of profit sharing: when profits fall, employees’ income automatically falls;
• a general reduction in unionisation in the private sector;
• in firms where workers are still unionised, unions and management increasingly seeing themselves to be on the ‘same side’: thus unions more willing to explore flexibility;
• less support from state if people are unemployed;
• greater flexibility from the use of temporary or agency staff: these can be reduced in a recession, thus helping to protect the jobs of established workers.
The following podcast looks at this growing flexibility and why it has helped to restrict the rise in unemployment.
Podcast
The real economy: Labour market BBC Today Programme, Evan Davis (24/8/11)
Articles
Agencies placing more in new jobs Western Mail (4/8/11)
Staff appointments increase at subdued pace in July, according to latest Report on Jobs The Recruitment & Employment Federation, News Release (4/8/11)
Manufacturing week: How we got here The Telegraph, Roland Gribben (27/8/11)
Jobless figures show the real risk of creating a lost generation London Evening Standard, Jonathan Portes, Director, National Institute of Economic and Social Research (17/8/11)
Flexible working: is more legislation needed? Personnel Today, Laura Chamberlain (1/9/11)
Recruitment agencies ‘play a big part’ in flexible working The Sales Director, John Oak (10/8/11)
Questions
- Find out what has happened to real GDP, employment and unemployment over the past four years. (Try searching Reference Tables for GDP and Labour Market Statistics on the National Statistics site at http://www.ons.gov.uk/ons/datasets-and-tables/index.html.)
- Distinguish between ‘insiders’ and ‘outsiders’ in the labour market? How has the relationship between the two groups changed in recent years?
- Distinguish between functional, numerical and financial flexibility of firms? (See Box 9.8 in Economics (7th ed), Web Case 6.2 in Essentials of Economics (5th ed), section 18.7 in Economics for Business (5th ed) or section 8.5 in Economics and the Business Environment (3rd ed).)
- Examine the effects of wage rises being less than the rate of inflation on the profit-maximising number of full-time equivalent people employed. How is this influenced by the rate of increase in the price of other inputs and the ability of the firm to raise prices in line with inflation?
- Should firms be required by law to allow workers to demand flexible working conditions? What forms might such flexibility take?
Cycling generated £2.9 billion for the UK economy in 2010 – a rise of 28% over 2009. This amounts to an average ‘Gross Cycling Product’ of £233 for each of Britain’s 12½ million cyclists. What is more, the figures are likely to continue growing rapidly in future years. This is the central finding of the LSE report, The British Cycling Economy, authored by Dr Alexander Grous, a productivity and innovation specialist at the Centre of Economic Performance (CEP) at the London School of Economics.
The major benefits to the economy from cycling include the sale of cycles and accessories, cycle maintenance, the generation of wages and tax revenues from 23,000 people employed directly in bicycle manufacture, sales, distribution and the maintenance of cycling infrastructure. There are also health benefits. These are partly the direct benefits to the economy of fewer days taken in sick leave by cyclists (a contribution of £128 million in 2010) and partly the health and well-being benefits to the individual and the saving on healthcare expenditure.
But are enough people being encouraged to get on their bikes? What are the major incentives for people to cycle? The report identifies the following:
• Cycling being made both segment- and gender-neutral, appealing to the widest number of user groups, across all ages and genders;
• Coordinated and preferential traffic signals that facilitate faster and safer journeys;
• ‘Short cut’ routes in dense urban areas and capital cities that join arterial road routes;
• Traffic calming initiatives that include road narrowing and speed restrictions that range from 30km/h to ‘walking speeds’;
• Extensive parking and in some areas, designated women-only spaces with CCTV and enhanced lighting;
• Established bike rental schemes;
• Long-running training programmes for children;
• The prevalence of strict ‘liability laws’ that assume a car driver is responsible in the event of a collision between a car and a cyclist.
Read the following articles and report and then consider, as an economist, how the benefits and costs should be analysed and what policy implications might follow.
Articles
Wheels of fortune: how cycling became a £3bn-a-year industry Independent, Tim Hume (22/8/11)
Cycling worth £3bn a year to UK economy, says LSE study Guardian (21/8/11)
Cycling industry gives economy £3bn boost BBC News (22/8/11)
Growth in cycling ‘boosting economy’, says LSE BBC News (22/8/11)
Britain Gets Back On Its Bike British Cycling (22/8/11)
‘Gross Cycling Product’ worth £2.9bn to UK economy says LSE Road.cc (22/8/11)
Report
The British Cycling Economy: ‘Gross Cycling Product’ Report LSE, Dr Alexander Grous
Questions
- How is the figure of £2.9bn derived? Explain whether it is a ‘value-added’ figure?
- Which of the benefits can be regarded as externalities?
- Are there any external costs from cycling? If so, what are they and how might they be minimised?
- How might incentives be changed in order to encourage more people to cycle?
- Assume that you are a government or local authority considering whether or not to increase investment in cycle paths. What factors would you take into consideration in order to make a socially efficient decision?
Friday 5 August 2011 saw the end of a very bad fortnight for stock markets around the world. In Japan the Nikkei 225 had fallen by 8.2%, in the USA the Dow Jones had fallen by 9.8%, in the UK the FTSE 100 was down 11.6% and in Germany the Dax was down 14.9%. In the first five days of August alone, £148 billion had been wiped off the value of the shares of the FTSE 100 companies and $2.5 trillion off the value of shares worldwide.
But why had this happened and what are likely to be the consequences?
The falls have been caused by the growing concerns of investors about the health of the global economy and the global financial system. There are worries that the European leaders at their summit on 21 July did not do enough to prevent the default of large countries such as Spain and Italy. There are concerns that the US political system, following the squabbling in Congress over raising the sovereign debt ceiling for the country, may not be up to dealing with the country’s huge debts. Indeed, the rating agency, Standard & Poor’s, downgraded the USA’s credit rating from AAA to AA+. This is the first time that the USA has not had top rating.
Then there are worries about the general slowing down of the world economy and how this will compound the problem of sovereign debt as it hits tax revenues and makes it harder to reduce social security payments. Underlying all this is the fear that the problem of indebtedness that contributed to the banking crisis of 2007/8 has not gone away; it has simply been transferred from banks to governments. As Robert Peston states in his article, linked to below:
The overall volume of indebtedness in the economy is therefore still with us – although it has been shuffled from financial sector to public sector.
And if you took the view four years ago that the quantum of debt in the system was unsustainably large, then you would argue that by propping up the banks, the day of reckoning was being postponed, not cancelled.
… just like the awakening in 2007 to the idea that many of the housing loans and associated financial products were worthless, so there is a growing fear that a number of financially overstretched governments, especially in the eurozone, will not be able to repay their debts in full.
Which brings us to the consequences. Key to the answer is confidence. If governments can reassure markets over the coming days and weeks that they have credible policies to support highly indebted countries in the short term and to sustain demand in the global economy (e.g. through further quantitative easing in the USA (QE3)); and if they can also reassure markets that they have tough and credible policies to reduce their debts over the longer term, then confidence may return. But it will not be an easy task to get the balance right between sustaining recovery in the short term and fiscal retrenchment over the long term. Meanwhile consumers are likely to become even more cautious about spending – hardly the recipe for recovery.
Videos
Markets turmoil: What you need to know BBC News, Jonty Bloom (5/8/11)
Turmoil on stock markets persists as share prices fall BBC News, Robert Peston (5/8/11)
Global stock market crash – video analysis Guardian, Larry Elliott and Cameron Robertson (5/8/11)
S&P downgrade US AAA credit rating BBC News, Marcus George (6/8/11)
U.S. loses AAA credit rating Reuters, Paul Chapman (6/8/11)
U.S. loses AAA credit rating from S&P CNN (5/8/11)
US loses AAA rating ITN (6/8/11)
Shares slump amid euro fears Channel 4 News, Faisal Islam (4/8/11)
What triggered the turmoil? Financial Times, Sarah O’Connor and Edward Hadas (5/8/11)
Fears eurozone woes will spread BBC News, Stephanie Flanders (5/8/11)
Articles
FTSE 100 tumbles in worst week since height of the crisis The Telegraph, Richard Blackden (5/8/11)
Global recession fears as stock markets tumble to nine-month low The Telegraph, Alistair Osborne (3/8/11)
Global markets on the brink of crisis Guardian, Larry Elliott (5/8/11)
A week of financial turmoil: interactive Guardian, Nick Fletcher, Paddy Allen and James Ball (5/8/11)
Turmoil on stock markets persists BBC News (5/8/11)
Bank worries bring echoes of 2008 BBC News, Stephanie Flanders (5/8/11)
The origins of today’s market mayhem BBC News, Robert Peston (5/8/11)
Time for a double dip? The Economist (6/8/11)
Rearranging the deckchairs The Economist (6/8/11)
High hopes, low returns The Economist (4/8/11)
The debt-ceiling deal: No thanks to anyone The Economist (6/8/11)
Six years into a lost decade The Economist (6/8/11)
Debt crisis Q&A: what you need to know about Standard & Poor’s credit rating The Telegraph, Richard Tyler (6/8/11)
U.S. Will Roll Out QE3 After S&P Rating Cut, Li Daokui Says Bloomberg (6/8/11)
China flays U.S. over credit rating downgrade Reuters, Walter Brandimarte and Gavin Jones (6/8/11)
US credit rating downgraded to AA+ by Standard & Poor’s Guardian, Larry Elliott, Jill Treanor and Dominic Rushe (5/8/11)
Reaction to the US credit rating downgrade Guardian (6/8/11)
Market turmoil and the economics of self-harm Guardian, Mark Weisbrot (5/8/11)
Week ahead: Markets will sort through credit downgrade Moneycontrol (6/8/11)
S&P Statement
S&P statement on lowering US long-term debt to AA+ Guardian (6/8/11)
Stock market indices
FTSE 100: historical prices, 1984 to current day Yahoo Finance
Dow Jones Industrial Average: historical prices, 1928 to current day Yahoo Finance
Nikkei 225 (Japan): historical prices, 1984 to current day Yahoo Finance
DAX (Germany): historical prices, 1990 to current day Yahoo Finance
CAC 40 (France): historical prices, 1990 to current day Yahoo Finance
Hang Seng (Hong Kong): historical prices, 1986 to current day Yahoo Finance
SSE Composite (China: Shanghai): historical prices, 2000 to current day Yahoo Finance
BSE Sensex (India): historical prices, 1997 to current day Yahoo Finance
Stock markets BBC
Questions
- Why have share prices been falling?
- Does the fall reflect ‘rational’ behaviour on the part of investors? Explain.
- Why does ‘overshooting’ sometimes occur in share price movements?
- Why has the USA’s credit rating been downgraded by Standard & Poor’s? What are the likely implications for the USA and the global economy of this downgrading?
- How is the downgrading likely to affect the return on (a) existing US government bonds; (b) new US government bonds?
- Why might worries about the strength of the global recovery jeopardise that recovery?
- To what extent has the debt problem simply been transferred from banks to governments? What should governments do about it in the short term?