A summer of discontent with high debt and no confidence in policy tools

July was a silly month. Europe tried to stem a debt crisis with seemingly half its population on summer leave. Britain was obsessed with the Murdoch case, while the US tried frantically to avert a debt default.

Luckily, the US Congress proved Winston Churchill right this month, that Americans could be counted on to do the right thing - after they had exhausted all other possibilities. As an astounded world held its breath, Congress agreed at the last minute to lift the debt ceiling and cut US$2.2 trillion in expenditure, to be negotiated over 10 years. In other words, it's the next president's and the next Congress' problem.

The 'paper tiger' rating agencies that threatened a downgrade duly noted that nothing would be necessary for the moment. But the damage is already done.

Independent risk analyst Richard Christopher Whalen made the astute comment that the spread on credit default swaps for US sovereign debt is now 68 basis points, equivalent to a triple-B bond rating for other sovereign paper, not triple-A.

There is a difference between accounting and economic valuation. Gold prices are still rising, and the yen and Swiss franc are facing upward revaluation pressure. The financial markets are telling a different story from the politicians.

There is a pattern emerging from all this volatility. Despite the efforts of central banks to revive growth by printing money, while their governments struggle to curb growing debt overhang, the prospects for faster growth in the near future appear to grow dim. Indeed, discounting Nouriel Roubini's forecast of another 'perfect storm', the risks of stagflation for many advanced nations are rising above 50 per cent.

The advanced countries are already slipping into what has been called the 'Japanese liquidity trap', which bit in the 1990s when the Japanese government failed to reflate the economy despite its zero interest rates, fiscal spending and liquidity injection. Technically speaking, it occurs when monetary policy loses its effectiveness.