God help the Europeans and the Americans (and by extension, us). The first have a bunch of leaders who are too complacent; the second have a new administration apparently gripped by fear, unable to act.
The president of the European Central Bank, Jean-Claude Trichet, speaking at a Bank for International Settlements meeting in Switzerland overnight, is still talking about the need to keep inflation expectations “anchored” and insists there is no chance of deflation either in Europe or the world.
The ECB has the cash rate at 1.5%, but the Taylor Rule – a formula that determines how much a central bank should change its policy rate – suggests it should by minus 1%. So monetary policy in Europe is still tight, in line with the rhetoric from M. Trichet.
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And while President Obama’s chief economist Larry Summers says the world needs more fiscal measures to stimulate demand, Europe, led by the Germans, says enough has been done.
Meanwhile in the US, the Federal Reserve Board said three months ago it would start buying Treasury bonds to push long term interest rates down, but has not yet done so – even though yields have risen since then, putting more pressure on mortgagees and businesses.
And the Obama Administration does not seem to know what to do about the banks: America remains in the grip of a debate about whether to nationalise the banks and wipe out the shareholders and bondholders, or whether to buy the “toxic assets” to support their balance sheets.
Paul Krugman, the Nobel prize winning economist, writing in the New York Times, calls it “the Big Dither”. He says that somehow Obama’s top officials have convinced themselves that the troubled assets are actually worth more than the market is willing to pay for them, and that if these assets were properly priced, all our troubles would go away.
The president of the Federal Reserve Bank of Kansas City, Tom Hoenig, has shot that idea down in a clear and unequivocal speech this week, in which he said: “The losses in the financial system won’t go away.
“If institutions, no matter what their size, have lost market confidence and can’t survive on their own, we must be willing to write down their losses, bring in capable management, sell off and re-organise misaligned activities and businesses, and begin the process of restoring them to public ownership.”
In other words – nationalisation, that dread word, the one the Americans can’t seem to pronounce. Also; forget the doctrine of “too big to fail”.
Hoenig is also talking about allowing bondholders, as well as shareholders, of these institutions to lose their money as well. At the moment, policy seems to be aimed at protecting bondholders from losses, which is misguided.
The British authorities have acted the most decisively. They have nationalised banks and the Bank of England has now started buying gilts (bonds) to get long term interest rates down.
The Australian authorities have so far not been paralysed by either fear or complacency, despite the political absurdities filling the air, although time will tell whether last week’s monetary policy pause was a mistake.
But at least they guaranteed the banks’ funds inflow and fiscal stimulus here is at the top end of the international range as a percentage of GDP. Interest rates will, nonetheless, have to come down further.
This article first appeared in Business Spectator.