It’s starting to look like the Summer of Love. Two reasons: The recovery is taking on a L-U-V shape globally, and it’s going to require huges amounts of love and nurturing to keep growth alive.

• L stands for Europe, where slowness to confront deep damage and write down the remaining $500 billion odd in bad bank debt, mean rebuilding will be protracted and painful.
• The United States sports a U, bouncing along bottom right. But its financial giants swallowed harsh medicine early and the U.S. has the flexibility to stage an impressive rebound, if not undone by a fast-rising jobless rate at 9.5 percent and heavily indebted consumers.
•  V stands for Asia (ex Japan), the surprise region showing resiliency, thanks to its rapid Q4/Q1 inventory workdown and huge infrastructure spend by China.

Like the Summer of Love 41 years ago, it is a drug-fueled affair. G20 governments are peddling $820 billion in stimulus this year, equivalent to 2 percent of GDP. Central bankers are spending even more. The Fed has doubled its balance sheet to $2.04 trillion the past 12 months.

These actions might have cushioned a severe cyclical downturn but the structural adjustment to a world of costlier credit is only just beginning.

Will politicians and central bankers have the wisdom or the stomach to keep the drug supply going long enough to prevent L-U-V from turning into an ugly W?

Central bankers have not had much reason to be happy over the last two years, as the financial crisis has lurched from bad to worse.

But the European Central Bank at least is now finding comfort in the fruits of its injection of close to half a trillion euros in 12-month funds last week, which has pushed money market interest rates to new record lows. 

“We are very happy, we see clearly that we decreased the risk premia,” ECB President Jean-Claude Trichet said on Thursday, after the ECB kept its benchmark rate on hold at 1 percent.

Still, the ECB’s generosity in filling bank coffers with cheap cash could paradoxically help financial institutions defer the day of reckoning when they will have to write down bad loans and toxic assets on their books, and adjust their balance sheets. Flush with ECB cash, banks could be encouraged to think they can hang on to past investment mistakes, rather than writing them down now. 

The Swiss-based Bank for International Settlements, a forum for the world’s central banks, says this painful process is a prerequisite for financial and economic recovery, and the International Monetary Fund  says the euro zone is lagging the United States in writedowns.

Maybe the ECB is not helping.

Has German Finance Minister Peer Steinbrueck finally said what many world leaders think but are afraid to say? That the British government won't sign up to meaningful reform of financial markets because it is too worried about what it would mean for the country’s most famous cash cow, the City of London.

The City, which accounts for around 35 percent of global foreign exchange turnover, has been a popular target for critics of capitalism for years. But it has rarely been singled out so bluntly as a problem by one of Britain’s close allies.

Even for a man not known for holding his tongue, Steinbrueck’s remark on Wednesday that Downing Street was impeding reform because it had “practically aligned” its interests with the City, was unusually undiplomatic. Just days before global leaders meet at a Group of Eight summit in Italy, Steinbrueck suggested the British government was plotting a “restoration” of the pre-crisis order to protect its own interests. The United States, by contrast, was now open to reform, he said.

Rather than attempting to smooth ruffled feathers when she addressed parliament on Thursday, Chancellor Angela Merkel picked up the thread, saying she would not tolerate efforts to stall reform at the G8 summit, though she did not name Britain.

Steinbrueck’s comments generated a strong response on German websites. Though he belongs to the centre-left Social Democrats, many readers of conservative daily Die Welt wrote in to praise him. “Finally the truth”, “genius” and “backbone” were some of the remarks his stance provoked. Across the channel, the most popular reader’s comment posted online in an article by Eurosceptic British newspaper the Daily Mail also backed the 62-year-old. “I’m with the German finance minister,” it begins.

Whether one agrees with his approach or not, Steinbrueck knows he is not talking into a vacuum. Large swathes of the commentariat believe not enough has been done to stabilise financial markets over the long term. Martin Wolf, chief economics commentator of the Financial Times, wrote on Wednesday that without radical changes, another banking crisis is inevitable.

PHOTO: German Finance Minister Peer Steinbrueck addresses a news conference in Berlin, May 13, 2009. Steinbrueck said on Wednesday Germany's interbank lending sector was still suffering from weak confidence. REUTERS/Fabrizio Bensch

Johns Hopkins University economist Christopher Carroll thinks U.S. consumers have finally got religion when it comes to saving, after years of free spending. For the sake of the broader economy, he is hoping they take to heart the prayer of Saint Augustine.

Carroll, a leading scholar on how housing wealth boosted U.S. consumer spending, has a new paper out on how the financial crisis of the past two years has affected attitudes toward spending and saving. It isn’t pretty.    

 

“Our view is that American consumers are not merely resting from their former role as the world’s champion consumers, they are permanently reforming their spending patterns, in response to the end of the period of ever-more-available credit that fueled the unsustainably high spending of recent years.”

In other words, Carroll thinks spending will be weaker than most economists expect in the short term. The savings rate, which briefly turned negative during the height of the credit boom, will probably go back to the levels seen in the 1970s, when households routinely socked away 8 to 10 cents out of every dollar.

That would certainly put Americans on more sound financial footing, but a rapid rise in savings means a swfit drop in spending, and that is the last thing the U.S. and global economy need right now. That’s where Saint Augustine comes in.

“After so much lamentation about low saving, it may be a bit hard for the
public to stomach economists’ new worries about a drop in spending,” Carroll writes. “But the contradiction can be understood by analogy to the prayer of Saint Augustine, who after a youth spent in debauchery decided to convert to Christianity to preserve his mortal soul. He was still enjoying his sinful ways when he made that fateful decision, so his first prayer was ‘Lord, make me chaste – but not quite yet.’”

Greedy bankers are routinely blamed for the credit crisis but one British-based poll of — well, financiers — spreads the blame more widely.

Gary Jenkins, head of fixed income research at Evolution Securities, wanted a more specific scapegoat and ran a poll of about 200 mostly fund managers and investors asking them to pick their credit crisis culprit. Former U.S. Federal Reserve Chairman Alan Greenspan was the clear winner, picking up 35
percent of the votes. He has been widely criticised over the past year for low interest rate policies that helped fuel the credit boom.

Former U.S. president Bill Clinton also figured quite prominently with about 10 percent of  votes, and British prime minister Gordon Brown got quite a few.

Some bankers were singled out, including Fred Goodwin, former chief executive of Royal Bank of Scotland and Richard Fuld, the head of collapsed Lehman Brothers.

In a related article in Euroweek, Jenkins also had a unique culprit — Bill Gates of Microsoft. None of the maths behind structured credit could be done without spreadsheets like Excel, Jenkins reckons.

So who do you think is to blame?

(Reuters photo: Kevin Lamarque)

There is little doubt that the BRICs — Brazil, Russia, India and China — have become big players in Africa. According to Standard Bank of South Africa, BRIC trade with the continent has snowballed from just $16 billion in 2000 to $157 billion last year. That is a 33 percent compounded annual growth rate.

What is behind this? At one level, the BRICs, as they grow, are clearly recognising commercial and strategic opportunities in Africa. But Standard Bank reckons other, more individual, drivers are also at play.

In a new report, the bank looks at what each of the individual BRIC countries is trying to do. To whit:

– Brazil’s immediate intererest in Africa is securing access to natural resources, particularly oil. But is also motivated by a desire to create a new “Southern Axis” with itself at the forefront.

– Russia is also interested in Africa’s natural resources. But it faces a problem because of the sullied reputation of the Soviet Union during the Cold War. So Moscow has also embarked on a rebranding programme within the continent by ramping up its aid programmes.

– India is attracted to Africa in part because of long historic ties. Commercial engagement, however, is also motivated by a need to guarantee the natural resources it needs for its own growth. Furthermore Africa is seen politically as a key ally in the pursuit of a competitive advantage over its Asian competitor China.

– For China, Africa provides a long-term partner in its ongoing bid to gain global economic ascendancy, providing it with the resources, markets, geopolitical support, and, eventually, food and social security in the form of a growing and engaging diaspora.

A full copy of Standard Bank’s report, which was written by Simon Freemantle and Jeremy Stevens, can be found here.

(Photo: Jeremy Gaunt)

Economist James Hamilton was pretty offended by the rough treatment of Federal Reserve Chairman Ben Bernanke last week at the hands of some U.S. politicians. But when he put up a defense of the Fed chief on his blog, he got an earful from readers who were critical of the U.S. central bank and suspicious over its role in the financial crisis and last year’s bank bailouts.

Some members of the House of Representatives Oversight Committee quizzing Bernanke last week voiced outrage over the Fed’s role in Bank of America’s takeover of Merrill Lynch. They claim the Fed covered up pressure on BofA to swallow massive Merrill losses in order to protect the wider economy.

Hamilton said they were trying to turn Bernanke into a scapegoat.

“These interrogations reveal more about those doing the grilling than they reveal about Bernanke,” Hamilton, an economics professor at the University of California, San Diego, wrote on his blog. “I see this as pure political theater, and I don’t like it.”

But some of his readers reckoned that the Fed chief, a former economics professor with whom Hamilton had corresponded in the past, is getting what he deserves.

“The question is not if the man is a good man. The question is, did he participate in a crime, the crime of knowingly help screw BOA shareholders out of millions?” argued one commentator. “I think he’d look good in orange. He can help the other inmates with their financial planning.”

What’s your take? Is Congress disrespecting Bernanke or did he have it coming?

Five things to think about this week:

WHAT Q3 HOLDS 
-  Global stocks are on track for their best quarterly performance in the 20-year history of the MSCI world index in Q2. But it will take better economic data than in recent weeks and positive earnings surprises to give the rally new impetus as Q3 kicks off, especially since volatility and liquidity remain preoccupations.

FINANCIALS 
- The Q2 reporting season looks set to highlight the gulf between financial institutions which are emerging in robust shape from the crisis and those still plagued by credit losses. Mark-to-market accounting changes and other factors may have distorted Q1 earnings but quarter-on-quarter comparisons could prove less flattering for those which have not been lucky enough to rack up high earnings, enjoy high margins and healthy trading revenues and pick up market share from defunct or weaker rivals. Recommendations in the next few days and weeks from a clutch of national and European authorities on the future landscape of regulation could throw some curveballs but will also offer a clearer picture of what banks will look like in the future. 

JOBLESS SPOTLIGHT 
Jobless data is lagging but some key unemployment numbers next week, including from the United States, will offer clues on how deep the domestic demand downturn will be and how much of a shadow labour market woes will cast over consumer sentiment and household purchases -- vital indicators for firms looking for signals as they take decisions on inventory rebuilding. 

CENTRAL BANKS 
- The ECB will be next after the Fed to perform the balancing act that central banks are engaged in as they try to manage markets' inflation and rate outlook expectations. Breakevens on French inflation-linked bonds have eased from May peaks but those fretting about the QE exit strategy still want reassurance. Some central bankers are flagging the need to turn off the fiscal taps at the right time but the sharpness of these warnings will be tempered by a reluctance to trigger a sharp back up in yields while the market-imposed need for fiscal discipline is being blunted by these central banks' bond buying. 

ISSUANCE
- Huge borrowing and debt issuance from major countries around the world ensure that long-term inflation is still a concern for some people in financial markets, despite soft economic data and huge capacity utilisation slack pointing to extremely subdued price pressures. Front-loading by some sovereign issuers still leaves plenty of supply to come onto market in H2. Question marks remain over how such supply will be absorbed, and whether shifts in household savings rates will help.

Eighteen months into the worst recession in decades, and the pain of the downturn is reaching into nearly every U.S. state, city and municipality.

With ever more people out of work, consumer spending has dried up, depriving local government of sales tax revenue. The continued housing slump has wiped out real estate transfer taxes, while declining corporate profits have eroded business tax revenue.

From Maine to California, the slump has drained coffers at the very time that the cost of providing jobless benefits and healthcare has risen, straining public finances.

Over the coming week, Reuters.com will publish a series on the problems facing states and cities. From Aurora, Illinois, Karen Pierog reports on the hardship created by the closure of a shelter for battered women, a victim of the crisis in U.S. social services.

Nick Carey visited the town of Pontiac, Michigan, and reports on the desolation wrought by the bankruptcy of General Motors. From San Francisco, Jim Christie and Peter Henderson report on the ticking time bomb created by California’s fiscal crisis as the state Treasurer prepares IOUs for suppliers.

Tom Ryan in New York and Andrew Stern in Chicago outline the burden that extended jobless benefits are putting on the funds that states use to pay the unemployed. From Miami, Michael Connor reports on how U.S. ports are being battered by the stark drop in trade volumes, a direct result of the collapse in American consumer demand and global trade.

Municipalities around the country are cutting services, laying off staff, furloughing others, scaling back pension entitlements and raising fees on everything from parking to soda bottles to plastic bags and cellphone ringtones.

As many as 46 U.S. states are facing fiscal 2010 budget deficits totaling at least $130 billion, according to the Center on Budget and Policy Priorities.

That’s up from 42 states with mid-year shortfalls of a combined $60 billion in the current fiscal year, according to the Washington think-tank.

Stimulus funds are a help and without them, the fiscal stress would be a lot worse. But the programs devised by the Obama administration are not sufficient to plug the gap, leaving governors and mayors with no choice but to cut spending and raise taxes — unpopular measures at any time but especially unwelcome as many families are struggling to make ends meet.

Because state revenue tends to lag economic activity, things will get worse before they get better, according to S&P Chief Economist David Wyss. Municipalities are typically the last to feel an economic recovery.

Mayors from around the country last month called for direct aid to cities arguing that they have been short-changed by the stimulus program money. Like many federal initiatives, the stimulus program makes states the primary conduit for funds, and urban centers feel they are disadvantaged compared to rural areas that have greater political clout.

“The toughest part is cutting back on programs and services that people really want in their communities, and having to explain to them why we can’t do certain things any more because we just don’t have the money,” said Philadelphia Mayor Michael Nutter.

Read more on our special coverage page, Economy: U.S. State Budgets

It may be some weeks since investors have written off the prospect of a V-shaped economic recovery, but equity analysts still expect corporate earnings to go through a very sharp V-shaped rebound.

According to Thomson Reuters data, earnings are expected to shrink 34.5 percent in Q2 and 21.4 percent in Q3, before growing a whopping 180.2 percent in Q4.

That would bring the full-year 2008 earnings contraction rate to just 11.2 percent.

“It is clearly positive that a depression is no longer feared. However, this is more or less compensated for by the forecast that the global economy will not grow by enough in 2010 to achieve the earnings growth that the markets are currently making allowances for,” ING Investment Management said in a note to clients.