The U.S. Federal Reserve, fully knowing that it might stoke inflation after lowering interest rates aggressively, decided that the risk of a significant slowing in the economy was higher than that of runaway inflation, says the Wall Street Journal. The Fed's decision and the ensuing data in Europe may lead the reluctant European Central Bank to do the same.
According to the Wall Street Journal, members of the Federal Reserve have both "defended" the recent rate cut and noted that the next set of moves will be decided on "economic events, rather than on financial markets."
To be sure, this is classic Fedspeak, with a Bernanke twist, meaning that you could actually understand the words, but that you're still not sure as to what the bank will do, as opposed with Greenspan's version of Fedspeak, where you couldn't make heads or tails out of anything that the old Fed Chairman mumbled into a microphone.
One easy to understand, but not exactly helpful set of remarks came from Fed Governor Kevin Warsh, who "said the Fed's next move depends on economic events, rather than on financial markets." According to Warsh '"The goal of our policy...is not to look at any particular asset class" but instead is to watch "what's happening in the real economy. We are going to stay very closely focused on real-time indicators and forward indicators."'
Of course, he did not mention which forward indicators, which leaves open the question about whether the Fed will start watching the financial markets, especially the stock market which traditionally trades on traders' expectations of activity 6-9 months down the road.
Fed Vice Chairman Donald Kohn, in a speech in Germany, noted that the Fed would not have lowered interest rates if "housing prices had continued their upward march," while adding that at some point in the future studies "done with cooler reflection" and less emotion than that currently being stoked by the subprime mortgage implosion, will likely show that "the causes of the swing in house prices will be seen as less a consequence of monetary policy and more a result of the emotions of excessive optimism followed by fear experienced every so often in the marketplace through the ages."
In other words, at least one key Federal Reserve voice seems to think that the central bank is mostly blameless in what happened and that the usual excesses of the marketplace were to blame for the problems, leaving the poor litte central bank with little recourse but to come in and save the day.
Meanwhile, in Europe, at least one bank, the U.K.'s Northern Rock required a major government bail out, with its problems related to the subprime debacle in the U.S., as the bank got caught holding lots of worthless paper.
The situation in Northern Rock may be a prelude of what's to come in other places in Europe, which means that central bankers in the EU, who have already added billions of liquidity to the economy through temporary operations, might be preparing to lower interest rates as well.
One major concern in the EU is the strength of the Euro, which has made record highs against the dollar as the Federal Reserve lowered interest rates. The dollar was already weak when the central bank lowered rates, and the drop seems to have accelerated the process that was already under way.
According to the Wall Street Journal: "The Northern Rock episode illustrates how the credit turmoil that began with risky mortgages in the U.S. could be setting the U.K. up for a fall. As with Northern Rock, many mortgage lenders are having difficulties getting the money they need to keep lending, a factor that could destabilize a U.K. housing market that already appears to be reaching the end of a boom."
The Journal describes the precarious state of the U.K. economy where "In the past decade, U.K. consumers have become more dependent on borrowed money, both to buy homes and to finance spending. As of July, total mortgage debt in the U.K. had reached £1.1 trillion ($2.2 trillion), more than double the level of 10 years earlier and equivalent to more than 80% of annual gross domestic product. In the first quarter of this year, U.K. homeowners tapped their home equity for about £13.2 billion, or 6.1% of disposable income, an indication of how much rising home prices have been raising consumer spending, which makes up about two-thirds of the U.K. economy."
Meanwhile "Northern Rock wasn't alone. Other lenders -- such as Paragon Group of Cos., which focused on customers who bought homes to rent out -- took the business model still further, relying entirely on wholesale capital markets to fund their operations.'
One source told the Journal that Paragon may run into significant trouble in the near future, although the company denies any such allegations.
More interesting is the quiet dispute between France's newly elected conservative president, Nicolas Sarkozy, and the EU Central Bank's chief Jean Claude Trichet. Sarkozy is
According to Bloomberg: '"Since becoming president, Sarkozy has declared a war of words aimed at pressuring fellow Frenchman Trichet to lower interest rates. ECB policies, Sarkozy says, are stifling France's economic growth; Trichet, by leaving rates unchanged after pumping cash into the money markets, has merely ``facilitated speculators.'' '
In a bizarre, albeit long distance exchange, 'Trichet, who initially tried to ignore him, has begun blasting back. At a meeting of European Union finance ministers in Oporto, Portugal, this month he ridiculed the president's comments, drawing laughter by observing that after the ECB had delayed a rate increase Sept. 6, ``President Sarkozy said he approved of what we did and he thought it was due to his influence.'''
Yet, this is not new as "The bad blood between the two most influential Frenchmen goes back more than a decade. As budget minister in the 1990s, Sarkozy frequently sparred with Trichet, then head of the Bank of France, over deficits. These days, Sarkozy criticizes the bank's exclusive focus on inflation, complaining that it keeps interest rates and the value of the euro too high."
Still, pressure on the European Central Bank is growing from other sources as the strength of the Euro is seen as leading to a possible slowing of the Eu economy. According to the Wall Street Journal: "A sharp deterioration of the index in the survey of European purchasing managers suggests the rising euro and spreading credit crunch are casting a shadow over the euro zone's economy. The report offered new ammunition to politicians calling for the European Central Bank to cut interest rates."
Even the ECB's own data was pointing to a slowing EU economy as early as July as "the euro zone's surpluses in its trade in goods and in services both narrowed substantially in July. That's a sign that the recent strength of the euro is beginning to hurt exporters," reported the Journal.
Conclusion
The Fed was late in joining the liquidity party when the subprime mess hit the news, but it has now jumped ahead of all other major central banks in lowering interest rates and making it known that it is firmly in control of the situation, as far as can be expected.
The ECB, hampered by the EU's restrictive legislation aimed at keeping budget deficits within certain limits, the threat of seeming to be politically influenced, and its own inflation targets, now finds itself in a box.
The strength of the Euro, though, and the realities of the marketplace, unless these processes are reversed, will eventually lead the ECB to do what it doesn't want to do. |
