The North Atlantic hurricane season runs from mid-August to October, with a strong peak in storm activity around the middle of September. A less familiar but even more destructive pattern of disturbances is the financial hurricane season, which coincides with the meteorological one almost to the day.
Most of the great financial crises of modern history have occurred in the two months from mid-August: the Wall Street crashes of Oct. 22, 1907, Oct. 24, 1929, and Oct. 19, 1987; Britain’s abandonment of the gold standard on Sept. 19, 1931; the postwar sterling devaluation on Sept. 19, 1949; the collapse of the Bretton Woods global monetary system on Aug. 15, 1971; the Mexican default that triggered the Third World debt crisis on Aug. 20, 1982; the breakup of the European exchange-rate mechanism on Sept. 16, 1992; the Russian default on Aug. 17, 1998, the bankruptcy of Lehman Brothers on Sept. 15. 2008 – and this list could go on.
The coincidence between financial and meteorological hurricanes may not be entirely fortuitous. The global economy, like the world’s atmosphere, is a finely balanced complex system.
In such systems, small perturbations can accumulate to trigger big effects. And just as the meteorological tipping points tend to occur when autumn air circulation starts to disrupt the humid air accumulated in the summer doldrums, something similar seems to happen to financial markets when trading becalmed by the summer holidays returns to normal. The result can be sudden and violent reaction to events accumulated over the summer that markets had seemed to ignore.
The world economy does not, of course, experience hurricanes with the same regularity as the Caribbean. But when big events happen over the summer, financial disturbances become quite probable in the fall. This is probably the reason why September has historically been the worst month of the year for stock market performance. In fact, September is the only month in which Wall Street prices have, on average, declined since the 1920s.
The question now is whether the world economy has already adjusted to the potentially disruptive and disappointing economic events of the summer, or whether the summer doldrums in financial trading were merely a calm before the storm.
The testing period begins this week with Thursday’s ECB meeting and Friday’s U.S. job figures. Further challenges to financial confidence are likely from the German constitutional court verdict on euro bailouts on Wednesday and the Federal Reserve decision on quantitative easing the following day.
But rather than focusing again on these familiar issues, it is worth considering some worrying developments recently in other parts of the world. In China, economic activity has failed to accelerate as expected, despite repeated attempts at monetary and fiscal stimulus. This could mean simply that the government and the central bank have not yet done enough. It is possible, however, that the Chinese economy has become too complex to be managed and fine-tuned as effectively as in the past. Or perhaps the disappointing results of Chinese stimulus thus far reflect a broader failure of monetary policy, which is becoming evident around the world.
Recent disappointments in Britain support the latter interpretation. The British economy has enjoyed no growth for two years now, since David Cameron’s government decided on a radical experiment in fiscal belt-tightening, hoping that monetary expansion would offset the deflationary effects. This week Cameron responded to the failure of this experiment by sacking many of his ministers and announcing a new “pro-growth” strategy.
On closer inspection, however, this “new” policy was simply doubling down on the one that failed. The growth measures consist mainly of promises to build unpopular new airports and railways from 2015 onwards. Meanwhile, the government will continue to cut spending and raise taxes, hoping that further monetary handouts to banks and bond investors will revive growth. The experience of the past four years suggests this is unlikely.
But if Britain cannot revive its economy with monetary easing, why should better results be expected from the Fed? Ben Bernanke, in last week’s Jackson Hole speech, effectively promised to keep pumping money into the U.S. bond markets until he achieved a strong economic recovery. But given that QE has failed to deliver full employment in 2010-12, why should it work any better in 2013?
Pumping money into the banks was a very effective emergency measure to prevent the collapse of the U.S. and British financial systems – and it could be equally effective in preventing the breakup of the euro, if only the German government would permit it. But financial stability and economic growth are different problems, and they may require different solutions. Unfortunately policymakers do not seem to understand this distinction. In the U.S. and Britain they refuse to acknowledge that printing money can ever be counterproductive. In Germany, by contrast, they refuse to accept that printing money can ever work.
Which brings us finally to the most important source of instability that threatens a financial hurricane this autumn – the impending clash between the ECB, Germany and the rest of the euro zone. This conflict, to which I will return next week, is certain to intensify between now and the next European summit on Oct. 19 – a date still well within the financial hurricane season.