2011-08-21 The global economy is having a heart attack

Fears of financial Armageddon proliferate as the global economy stutters, investors abandon hope and the euro teeters on the brink of collapse.

“This was the week that investors abandoned all hope,” the Financial Times dramatically reported on Friday. “Fears of a new credit crunch caused share prices to plummet on both sides of the Atlantic,” the Guardian wrote, ”as fragile banks struggle to raise funds in financial markets.” As a result, the shares of some of Europe’s largest banks fell to their lowest point in two years, while those of US banks fell back to levels unseen since the collapse of Lehman Brothers.

US borrowing costs fell below 2 percent “for the first time in at least 60 years,” as investors, wary of stagnating global growth and a renewed financial meltdown, scurried into traditional safe havens like gold, Swiss francs and treasuries. “There is a serious concern that you are going to get recession sooner or later,” said Jim Reid, credit strategist at Deutsche Bank. “It is a phenomenal period in history.”

The bloodbath in financial markets prompted Nobel Prize-winning economist Paul Krugman to warn: “OK, seriously: things are looking really terrible,” and Nouriel Roubini, another leading economist — actually one of the few to have correctly predicted the financial meltdown of 2007-’08 — to Tweet: “when banks & deposits arent safe & govs are bankrupt time to buy canned food, spam, guns, ammo, gold bars & rush to your mountain log cabin.”

“Make no mistake,” Larry Elliot, the Guardian‘s economics editor sternly concluded, “something serious is going on here.” As Sal Catrini, managing director for equities at Cantor Fitzgerald, put it: “the market is in meltdown mode; the data continues to stink. I don’t know that there’s much more to be said.” Indeed, this week’s data was nothing short of shocking. While eurozone growth ground to a halt, recent US figures showed a drastic decline in manufacturing output.

“Tension on trading floors is palpable,” the New York Times reported, “especially for the usually relaxed month of August.” Jack Ablin, chief investment officer at Harris Private Bank, lamented that ”every time the economy got the sniffles, we had the Federal Reserve standing by with tissues. This time around, I think the box is empty, and we’re going to have to go through this alone.”

After major swings in markets the week before, referred to by the New York Times as “one of the most harrowing stretches in Wall Street history,” the start of the past week seemed to bring back some stability. But the respite was short-lived, and stock markets quickly resumed the dramatic swings they started in the wake of Standard & Poor’s downgrade of the United States credit rating. As the Wall Street Journal reported:

Among investors, anxiety has been intensifying over the soundness of European banks despite repeated efforts to contain the sovereign debt crisis. The latest fears flared up after an unspecified lender tapped an emergency borrowing program set up by the European Central Bank to ensure that firms had ample funds in dollars.

As Reuters observed in an analysis, “watching the markets rise and fall like giant ocean swells has been an unnerving experience.” Indeed, “one might say Wall Street is a bipolar market that veers from despair to euphoria with each passing news headline.” This Thursday, the despair was unleashed by bad growth figures and a headline about an unknown European bank, apparently incapable of borrowing directly from a US bank, requested $500bn from the ECB.

Observing this bipolar behavior of financial markets (the New York Times reported that “stocks have zig-zagged to an extent that has not been seen for years”), I can’t help being reminded of Robert Wade, my Professor at the London School of Economics. In one of our first classes, he held up a graph from the Financial Times, showing the wildly gyrating Dow Jones index. ”This,” he dryly said, “is what it looks like when the global economy has a heart attack.”

Just two weeks before, Lehman Brothers had collapsed, marking the single largest bankruptcy filing in US history and the start of the largest financial crash and worst economic downturn since the Great Depression. And, as David Blanchflower, economics editor of the New Statesman correctly noted, ”what we are witnessing now could be worse even than what followed the fall of Lehman Brothers. These are extremely worrying days.”