Author: Jonathan Davis

When the equity and bond markets are both pointing in opposite directions, as they are at the moment, it is fashionable to trot out this question: which market is the most reliable as an indicator of what lies ahead? Time was when bond market investors, being vigilant for inflation and potential default, and naturally concerned, like bankers, more with what could go wrong than what might go right, could claim with some justice that their prices did the better job of guiding investors’ decisions.

A brutal May, a flat June, a happy July and then a lousy August – the equity markets continue to lurch alarmingly along a directionless path, with every monthly lurch seized on, by those with the strongest views, or at least the loudest megaphones, as evidence that their interpretation of events is right. It was not, fortunately, ever thus and nor will it be forever. In due course, we will find out in which direction the equity markets really want to go. My money still favours that direction being up, rather than down, but it could take one more painful downleg before the trend is finally established.

Stress tests should be subject to stress tests. Would the banks that passed the version of the test imposed by Europe’s financial regulators be able to fund themselves adequately if implicit or explicit state guarantees of their non-deposit liabilities were withdrawn? This further test should be applied to each bank individually, and for the group of systemically important banks as a whole. The outcome would indicate how far Europe’s banks have progressed in being able to survive without public subsidy. Not far, I suspect.

One of the great insights of 18th-century economics was that exchange can benefit both parties to a transaction. Since then, the mercantilist view – in which trade is a mechanism by which one party tricks the other into giving up something valuable for inadequate recompense – has disappeared from economic theory, if not popular discourse.