So says Ambrose Evans-Pritchard in the Telegraph, so it must be true. He writes: “As the credit paralysis stretches through its fifth month, a chorus of economists has begun to warn that the world’s central banks are fighting the wrong war, and perhaps risk a policy error of epochal proportions.” And what might that policy error be?
Buckets of liquidity are being splashed over the North Atlantic banking system, so far with meagre or fleeting effects … “Liquidity doesn’t do anything in this situation,” says Anna Schwartz, the doyenne of US monetarism and life-time student (with Milton Friedman) of the Great Depression.
Peter Spencer of York University continues:
“The central banks are rapidly losing control. By not cutting interest rates nearly far enough or fast enough, they are allowing the money markets to dictate policy. We are long past worrying about moral hazard … [The global financial authoritie] still have another couple of months before this starts imploding. Things are very unstable and can move incredibly fast. I don’t think the central banks are going to make a major policy error, but if they do, this could make 1929 look like a walk in the park”.
I’m not sure that the ‘chorus of economists’ saying that it’s an insolvency crisis rather than just a liquidity crunch is really so new – Nouriel Roubini was saying so back in mid-August, as we observed at the time – but let’s let that pass. Here are three interesting, if controversial, thoughts that emerge from E-P’s piece:
1. Remember what happened to Japan in the 1990s:
In theory, Japan had ample ammo to fight a bust. Interest rates were 6 per cent in February 1990. In reality, the country was engulfed by the tsunami of debt deflation quicker than the bank dared to cut rates. In the end, rates fell to zero. Still it was not enough. When a credit system implodes, it can feed on itself with lightning speed. Current rates in America (4.25 per cent), Britain (5.5 per cent), and the eurozone (4 per cent) have scope to fall a long way, but this may prove less of a panacea than often assumed. The risk is a Japanese denouement across the Anglo-Saxon world and half Europe.
2. E-P’s outlook for Britain:
The risk for Britain – as property buckles – is a twin banking and fiscal squeeze. The UK budget deficit is already 3 per cent of GDP at the peak of the economic cycle, shockingly out of line with its peers. America looks frugal by comparison. Maastricht rules may force the Government to raise taxes or slash spending into a recession. This way lies crucifixion. The UK current account deficit was 5.7 per cent of GDP in the second quarter, the highest in half a century. Gordon Brown has disarmed us on every front.
3. Something you may not have considered vis-a-vis the European Central Bank:
The ECB’s little secret is that it must never allow a Northern Rock failure in the eurozone because this would expose the reality that there is no EU treasury and no EU lender of last resort behind the system. Would German taxpayers foot the bill for a Spanish bail-out in the way that Kentish men and maids must foot the bill for Newcastle’s Rock? Nobody knows. This is where eurozone solidarity stretches to snapping point. It is why the ECB has showered the system with liquidity from day one of this crisis.
In other news, Nouriel Roubini finds that in 2007, cash (in short term Treasuries or money market funds) outperformed the stock market.
