The potential for disruptions to global financial stability increased heading into last weekend. In Europe, both Germany and the European Central Bank rejected calls to expand the bailout to include large-scale bond purchases, insisting instead that the latter’s credibility depends upon its prioritization of price stability.
At a gathering of the Frankfurt Banking Conference, German Bundesbank president and European Central Bank Governing Council member Jens Weidmann said on Friday that “the economic costs of any form of monetary financing of public debts and deficits outweigh its benefits so clearly that it will not help to stabilize the current situation.”
Dr. Weidmann declined to comment when asked if the bank had furtively adopted limits on its weekly purchases of eurozone members’ government bonds. The meeting’s air of ambivalence in addressing the continent’s crisis coincided with concessions on the growth outlook. In his first public address as ECB president, Mario Draghi opened his remarks by stating that “downside risks to the economic outlook have increased.”
The positions emerging from their most recent meeting suggest that Europe’s leadership is ultimately unwilling to install a credible backstop should the crisis engulf other nations. The significance of the European threat for the global outlook is reflected in the reactivity of equity indices in the United States, where markets have been whipsawed by daily shifts in the tenor of news emerging from across the pond. After resuming a measure of normalcy, the VIX spiked during the 11th hour of the summer’s budget debate in Washington and has been elevated ever since.
Somewhat brighter economic data have not mollified investor skittishness. Over the next days and weeks, attention will also be focused on domestic affairs and the seeming incapacity of congressional leaders to achieve compromise. While debt talks remain fluid and the true state of discussions remain wittingly hidden from the voting public, it is increasingly likely that the goals set for the Joint Select Committee on Deficit Reduction in August will be abandoned.
The utter failure of America’s divided leadership is unconscionable, as is the continuing pretense of well-functioning democratic institutions. And yet, while the domestic scenario bears an uncomfortable resemblance to diegeses in the nations we condescend to instruct in governance, the market mechanisms that are critical to disciplining the latter are loathe to rebuke the United States for its shockingly myopic behavior. As the relatively safest harbor during a time of exaggerated risk and risk aversion, our markets have seen an influx of capital even though some of the most far-reaching sources of instability are rooted here. The 10-year Treasury closed the week at a yield of just over 2 percent. Meanwhile, the TED spread, which proxies for risk aversion, has risen to its highest level since mid-2010.