Unmarked crossroads

The Great Stagnation spawns Great Confusion

The 24 hours that began Wednesday morning in London were all too typical of the Great Confusion. That is a good name for the current mindset of policymakers, outside experts and investors. The wait for clarity could be long.

First came an ambiguous report from the International Monetary Fund on the state of the UK economy. Investors were suitably puzzled. A few hours later Ben Bernanke, the US Federal Reserve chairman, pleased and then frightened investors with a maybe-yes, maybe-no policy non-pronouncement. The period ended with a bang, a stock market rout of uncertain cause in Tokyo.

What's happening?
First, the Great Stagnation: the inadequate GDP growth and unacceptably high unemployment in almost all developed economies. Second, the Great Disappointment: the continuation of stagnation despite historically high fiscal deficits, radical monetary policy and lots of financial activism. Finally, the Great Confusion: investor frustration over having lots of money but very little conviction about what to do with it.

What happens next?
The gradually shrinking band of economic optimists could finally be proven right. Japan finds inflation, Europe rediscovers growth and the tentative US recovery really takes hold. Investors could then start worrying about inflation, but that would mark the start of a new chapter in economic and market history.

Alternatively, it could all go wrong. Scenarios abound: another financial crisis, perhaps this time with a Chinese epicentre; a political rupture, as stagnation breaks up the euro or political gridlock discredits the dollar; or a policy misfire that leads to crunched economies or frozen banks. When it comes to unhappy endings, the imagination is the limit. Most likely, though, is more stalemate. Policy can keep disaster at bay but not lift the financial miasma that sickens the economy. People and companies are too miserable to take big economic risks but not despairing enough to spur radical change.

In that dull economic scenario, real interest rates will remain negative. In response, investors will continue to flit here and there in an ultimately vain effort to overcome financial repression. Markets will be volatile and, overall, ultimately unsatisfactory. In short, the Great Confusion persists.