Flaherty helps steer efforts to calm economic jitters

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The Gazette, Wednesday, August 17, 2011

At his summer policy retreat at the Wakefield Mill Inn last week, Finance Minister Jim Flaherty occasionally stepped out onto the veranda to return calls on his BlackBerry.

Not that he wasn't interested in the advice that business leaders and academic figures had to offer, but there was a lot going on in the wider world.

In New York, the Dow was down 635 points on Monday, up 430 points on Tuesday, down 530 points on Wednesday, and up 423 points on Thursday. It was the first time in history it had moved more than 400 points up or down on four consecutive days. On Friday, it closed up 125 points to narrow its losses for the week to 175 points; on Monday it closed up another 214 points, to wipe out all the losses of last week.

It's a cardinal rule that while the finance minister watches markets, he never comments on them, or on exchange rates. But Flaherty did offer an observation.

"Too much attention," he said, "is paid to hour-by-hour fluctuation in markets."

Some of this churn is driven by CNBC's carny-barker coverage of the stock market, some of it by automatic computer selling from hedge funds and mutual funds. And some of it is event driven, as in the final hour of trading last Tuesday, when the market reacted to the announcement by the U.S. Federal Reserve Board that it would hold its central bank rate to near-zero levels for two years.

At first the Dow tanked 200 points on the Fed's gloomy economic forecast, before rallying to its 430-point gain - a swing of more than 600 points in just over an hour. The Fed didn't rule out other measures, such as another round of quantitative easing by buying back bonds.

In the absence of political leadership in Washington, it's welcome news that the Fed intends to use whatever is at its disposal in the tool kit of monetary policy. The Obama administration's hands are tied by the deal it just made with Congress to cut the deficit by $2.1 trillion over 10 years in return for extending the debt ceiling by an equivalent amount over two years. Another round of stimulus, such as the $800-billion package at the bottom of the Great Recession in 2009, is not an option.

But at least in America, monetary and fiscal policy are made in the same town. In Europe, it's different. There's a common currency for 17 countries in the eurozone, but no common fiscal policy, except for a widely ignored expectation that no country's deficit should be more than two per cent of GDP.

Tell that to the Greeks, or the Irish, or the Portuguese.

Greece's debt will peak at 160 per cent of GDP next year. This is why Greek 10-year bonds are yielding 17 per cent. Ireland's debt is 100 per cent of GDP, as is Italy's.

Someone is holding all that paper, and it's usually the banks. For example, Greek banks are more than 200 per cent exposed to their country's sovereign debt. In Italy, it's 175 per cent, according to European Union figures. German and French banks are holding a lot of debt from Greece, Ireland, Portugal, Spain and Italy, which is the main reason European and North American markets were so jumpy last week. It really had very little to do with the Standard & Poor's downgrade of the U.S. credit rating from AAA to AA+.

This is why Flaherty was on the phone to colleagues in mostly G20 countries during his policy retreat. On the weekend, the finance ministers of Canada, Britain, Australia, South Africa and Singapore put out an extraordinary communiqué basically calling on Europe to take all necessary means to restore confidence.

"The eurozone has taken steps to deal with the problems of contagion," they noted. "Now it needs to demonstrate greater commitment to fiscal integration and governance arrangements that avoid moral hazard."

As for America: "The United States plays an especially important role in restoring confidence. Credible fiscal commitments are in its own interests and the world's."

It's not every day you see leaders of other countries telling Europe and the U.S. to get their act together.

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