Time to reload the policy guns

Wild swings in global stock markets are emblematic of chaos in the collective mindset. Confusion reigns, and who can blame the participants?

Wednesday’s 520 point, or 4.6% decline in the US Dow Jones industrial Average marked a third day of heightened volatility. The market was up 4.0% on Tuesday, after a 5.6% crash on Monday.

Caught in the overall market downdraft was crude oil prices, which fell to about $80/bbl on the New York Mercantile Exchange (NYMEX) as of Wednesday – a far cry from $100/bbl as recently as late July. Oil prices tanked as players adjusted their economic growth expectations lower.

Petrochemical and polymers prices are poised to fall on the back of lower crude and diminished economic growth expectations. And the dire economic outlook is being reflected in chemical stock prices – few sectors have been hit harder than the industrial group.

For the month of August thus far, US bellwether Dow Chemical’s stock is down almost 19% while US-based Huntsman has lost a staggering 35% of its value. Germany’s BASF, the world’s largest chemical company, is down 22%, and Netherlands-based petrochemical and polymers giant LyondellBasell is off 21%.

The greatest threat to the global economy today is the loss of confidence – confidence that the US can get its fiscal house in order and reinvigorate its stalling economy, confidence that Europe can halt the spread of its growing sovereign debt crisis, confidence that China can get a handle on inflation without stamping out growth.

The S&P downgrade of US debt from AAA to AA+ did not cause interest rates to rise – not yet. In fact, US bonds rallied, driving down yields even further as the market shifted its focus to the growing likelihood of a recession. Indeed, the US Fed made an explicit statement to keep interest rates low for years to come to support the economy.

The bigger blow of the downgrade is to consumer and business confidence. US government debt – as close to a “sure thing” than anything – is that no longer.

You can indeed talk your way into a recession. Negative sentiment can trigger behavior that leads to a double-dip downturn. Watching stocks dive and sovereign credit ratings cut with no coherent policy response from governments and central banks might make you think twice about eating out for dinner, buying that new car, or building that cracker.

Leadership is needed in times of crisis. The European Central Bank (ECB) must act as the buyer of last resort for the sovereign debt of its members. Indeed, it swept in to buy Spanish and Italian bonds on Tuesday. The US must come up with a plan to boost its economy.

Much has been made of the point that policy-makers are “running out of bullets,” or “running out of rabbits to pull from the hat” to make things better. The US has already cut interest rates to near zero, and completed its second round of quantitative easing (QE2) featuring the purchase of $600bn (€420bn) in debt securities, in June.

But it’s time to reload the gun. There is no reason the ECB can’t reverse its tightening bias and lower interest rates. It has raised rates twice this year even in the face of severe fiscal austerity for some of its members. There is room to ease from its current stated level of 1.5%. The US has a stated interest rate target (Fed Funds rate) of 0-0.25%. The ECB can also embark on a round of QE, an increasingly likely scenario.

The US needs a plan to revive the economy, and this will require investment. So far, the world is waiting.

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