'Warming up for another crisis' unless politicians act
The central banks' status as "gods" that control the global economy is fading – and nothing really is ready to replace it
In Davos and at other summits of policy makers and business leaders the catchphrase this year seems to be cautious optimism.
Among the first one to use it was European Central Bank President Mario Draghi; then it was repeated by his ECB colleagues, such as Austrias central bank governor Ewald Nowotny and it became a sort of preferred mantra for political leaders everywhere.
In Davos, Draghi promised that a recovery will take place in the eurozone in the second half of the year while German chancellor Angela Merkel, in an attempt to show investors that something was being done on the continent, praised reforms in ... Central and Eastern Europe.
However, strategists say, this is really not enough to persuade markets that all will be well. On the contrary, the feeling that policy makers are wasting precious time is beginning to take root.
We are starting to realize that actually, central bank policy is no panacea for anything, Marc Ostwald, a strategist with Monument Securities, told Emerging Markets.
Ostwald said that throughout much of the 1990s and the first decade of this century, central banks were seen as gods that controlled the global economy.
What was always forgotten was that all that central banks do is create a financial backdrop, an economic backdrop in which politicians are given some time to act.
The problem of course is that were now in year 6 of this crisis and all thats actually happening is that central banks, with more and more extraordinary and unconventional and totally off-the-wall measures, keep on being asked to buy time for politicians who hope the problems will all go away. And theyre not going to.
US: CANT DO, WONT AGREE
In the US, the image that the rest of the world has of politicians as having an attitude of can do, will do is challenged by the fact that at the moment, they are cant do, wont agree on anything, Ostwald said.
The risks are rising the whole time the more that they dont act.
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In the eurozone the threats to stability from Greece, Cyprus, Spain, Portugal and Ireland are nowhere near long-term resolutions, while the interests of the various states in the single currency area are so divergent that the banking and political union that was enthusiastically advertised last year is a pipedream, according to Ostwald.
The UK needs to carry out deep structural reforms as well, with investment needed in transport infrastructure and in an education system that simply doesnt pass muster when it comes to employers actual needs, he added.
Hopes that the financial crisis had finally been overcome have boosted stock markets since the beginning of the year. In the US, the S&P 500 exceeded the psychologically important 1500 level last Friday, recording its longest winning streak since 2004. Some strategists predicted the index will hit 1600 this year.
Stocks rallied in Europe as well, with Germanys DAX hitting a five-year high last week.
LOOKING FOR TROUBLE
But Drew Brick, managing director for markets and international banking at RBS, believes the optimism is overdone.
We were also struck how little discussion there was about Europe and we wondered, at virtually every meeting, whether a sense of complacency had moved into a market which prices so many assets so rich right now, Brick wrote in a market note.
An S&P 500 at 1500? Consensus estimates for 2013 project a 14.5 S&P P/E with $100 earnings allowing for some buybacks. That means we already run some 50 S&P points too expensive by this Index and we're only one month into the year!
Ostwald said political leaders gave the impression that they were relying on central banks to buy them time so the economy improves on its own and things go back to the way they were before 2007 and 2008 when the crisis started.
The problem with that is that if we want to go back to then, were just looking for trouble. Were not addressing the issues that created the problem, he said.
Central banks policies have worked in keeping financial markets calm but they have not managed to increase the availability of credit and boost the economy, Ostwald said something that the ECBs Draghi has acknowledged as well.
The main risk, according to Ostwald, is that of social and labour tensions rising, like it happened in Egypt and Greece, and with that, preferences for populist politicians.
The risk is... that you get someone nasty appearing. A cheap, nasty demagogue.
The privileged and the ruling classes have got a big wake-up call on their hands and the question is can they actually get a grip on expectations management? I have my doubts, I have some serious doubts.Whatever they will have to do is not going to be popular, and they know it. But if they dont do it, then were just warming up for another crisis, Ostwald warned.