As the summer holidays wind down, the world is again moving into the financial Hurricane Season, which coincides uncannily with the meteorological hurricane season in the North Atlantic every autumn. Most great financial crises have occurred in the six weeks from late August to mid-October, for reasons I discussed in this column last September.
This year, exactly on cue, the seasonal risks are again building up: war in the Middle East; a watershed decision in U.S. monetary policy, plus the announcement of a new Fed chairman; a German election that could make or break the euro; the long-awaited “third arrow” of Shinzo Abe’s Japanese reform program; another internecine conflict over the U.S. budget and Treasury debt limit that could result in a government shutdown or even a temporary default. And I am not even counting probable policy upheavals in China, India, Brazil, Indonesia, Turkey and other crisis-ridden emerging economies, whose timing is less certain but which could also fall within the next few months.
The consolation is that confidence is likely to return to the world economy and financial markets if the political and financial storms blow over without too much damage. To gauge how the world is likely to fare under this barrage of uncertainties, consider them in turn.
While Syria is the most frightening, it is also the easiest to dismiss. To say this is not to belittle the carnage and human suffering in Syria; it is simply to recognize that war in the Middle East is effectively a continuation of the permanent status quo. The Middle East has been at war almost continuously for over 50 years, since the Suez Crisis, and internecine fighting will probably continue for many more years or even decades, as it did in Europe during the religious conflicts of the 16th and 17th centuries. Neither the global oil supply nor the balance of power between Sunni and Shi‘ite Muslims is likely to be significantly affected by whatever action the U.S. may or may not take — and that is what matters for global economics and geopolitics. Once the missiles have exploded, therefore, financial markets will probably enjoy a relief rally, as they usually do after military engagements in the Middle East.
The German election on September 22 now seems equally predictable. Optimists once hoped this election would usher in a period of more collaborative German leadership. Conversely, skeptics predicted financial and political crises once the new German government was revealed to be no less stubborn than the old one in blocking compromises on bank bailouts and fiscal targets. Recently, however, both positive and negative expectations have been deflated by the blandness of the German campaign, combined with the modest improvement in Europe’s economic conditions. Thus the main worry now for investors in Germany is no longer about the outcome of the election, but simply about how other investors will react after September 22.
In Japan, by contrast, the policy outlook is genuinely uncertain. Shinzo Abe could use the new Diet session starting next month to announce significant structural reforms, backed up by further monetary and fiscal stimulus. Japan would then enjoy an accelerating recovery and probably a continuation of the bull market that began last November. On the other hand, Abe could lose his nerve and fail to deliver reforms. In that case Japan would sink back into economic torpor — and the rest of the world would revert to simply ignoring Japan, as it has for the past decade.
That option will not be available if events in the U.S. veer off course — which brings me to the main source of financial and economic uncertainty this autumn, a confluence of four closely-related events in Washington: the monthly employment report on September 6; the Fed’s decision on monetary tapering on September 18; the announcement of a new Fed chairman around the same time; and the Congressional vote on Treasury debt limits by mid-October.
A very weak payroll report, with employment growth of under 100,000, would stir serious worries about the tapering decision two weeks later — about whether the Fed would actually dial back monetary expansion and about whether such a decision could be dangerously premature. A big number, on the other hand, would guarantee tapering and also provide some reassurance that the U.S. economy could withstand this move.
In either case, attention will quickly shift to the Fed succession and the debt ceiling vote. The appointment of Larry Summers now seems a foregone conclusion, but a worrying question remains. Why has President Obama apparently decided to back a candidate who will face furious opposition from both parties in Congress and whose views on monetary policy appear to be dangerously hawkish? An optimistic answer is that Summers may be proposing more radical combinations of monetary and fiscal policy stimulus than Ben Bernanke was willing to contemplate — for example, quasi-fiscal policies to support housing finance, as in Britain, or perhaps even the direct distribution of newly printed money to U.S. citizens, which economists call “helicopter money” and I have described in these columns as “quantitative easing for the people.” A grimmer alternative is that Obama believes a financial crisis is inevitable and is impressed, post-Lehman, with Summers’ fire-fighting skills. Whatever the real motivation, the Fed appointment will make investors nervous until it is finally settled and fully explained — which may be why Obama is uncharacteristically accelerating this decision, instead of prolonging the agony.
The same may be true about the debt ceiling vote. This vote was not expected until November or December, but the White House has unexpectedly brought forward the deadline to mid-October. This may reflect confidence about striking a deal with Congress, as Republican leaders back off earlier threats to shut down the government or trigger a Treasury default. Alternatively, the White House may fear that the U.S. economy will soon face a crisis and wants to trigger an early budget confrontation, so as to blame Republicans for whatever economic disappointments lie ahead. Either way, the fiscal uncertainty will be resolved by mid-October — and the financial hurricane season will be over for another year.