Return of the GFC

There’s been an unpleasant sense of déjà vu in financial markets over the past few weeks. Many of the symptoms of heightened investor risk aversion that characterised the global financial crisis of 2007-09 have re-emerged, including double-digit falls in many sharemarkets from their highs of earlier this year, substantially higher levels of volatility, falling commodity prices, declining bond yields, and a strengthening US dollar.

And even though Australia came through the crisis of 2007-09 in much better shape than most economies, Australian assets seem once again to have been harder hit - as they were in 2007-09 - with the Australian sharemarket among the worst-performing over the past few weeks, and more recently the Australian dollar experiencing an abrupt decline.

The renewed risk aversion of global investors appears to have been prompted by mounting concerns over two quite separate issues.

The first is the way in which European governments have responded to growing market concerns over sovereign debt.

There are some eerie parallels between the determination of contemporary European governments to avoid a Greek debt default, and to preserve the existing membership of the euro zone, with the efforts of their predecessors in the early 1930s to avoid defaulting on the debts incurred or imposed during and after World War I, and to remain on the gold standards. These efforts were not only ultimately futile, they actually made the Great Depression worse than it would otherwise have been.

The rhetorical and regulatory assaults by European governments on "speculators" in recent weeks also have striking parallels to that era.

Markets appear to believe that the most recent bailout package assembled by European governments, the European Central Bank and the International Monetary Fund have only deferred a Greek debt default, rather than averted it, and in so doing they have committed themselves to more contractionary economic policies than would have been required if the "inevitable" were allowed to happen sooner. This may eventually turn out to be wrong; but for the time being this view is driving investor behaviour.

Given the opprobrium that has been heaped on financial institutions, and markets more generally, for their role in bringing on the financial crisis of 2007-09, it's perhaps worth noting that the European debt crisis is almost entirely the making of governments.

It was a former Greek government that lied about the amount of debt it had incurred, and which entered into complex transactions designed to get around limits on borrowings by aspiring members of the euro zone. Other European governments (and the European Union) turned a blind eye to the fact that Greece (and other countries besides) had manifestly failed to meet the criteria for euro zone entry, and admitted them anyway.

And European governments failed to put their public finances in a sustainable condition during more propitious economic times. It's thus not entirely surprising, nor unwarranted, that European governments' pronouncements and actions in response to this crisis have been viewed so sceptically.

Although the focus of attention in recent weeks has been on members of the euro zone, other major economies also face an onerous task of restoring their public finances to a sustainable condition - including Britain, Japan and the US.

The possibility therefore exists that market attention will at some point turn to the credibility of any, or all, these countries' debt-reduction strategies, meaning the pressures now emanating from Europe could appear elsewhere.