Sep 19 2007
The Fed starts to solve the problem
As expected, the Federal Reserve Board is the first of the major central banks to realise the credit squeeze is too tight and interest rates need to be lower. It is good news that they have cut by 0.5% (50 basis points) in one go, to show markets they are serious about wanting to ease credit conditions.
It makes the actions and inactions of the UK authorities over the summer even more difficult to defend. The Chancellor and Bank simply watched as market interest rates rose above the Bank rate, as inter-bank lending dried up, and as cash became very short.
The UK banking system did not need a “bail out” and should not have needed the extraordinary taxpayer guarentee on all deposits. What it needed was a UK monetary authority that realised money market conditions were too severe, and cash in too short supply. Individual banks cannot issue banknotes and Treasury Bills. The Government and Bank of England control that monopoly, and did not handle it properly to preserve banking stability.
The UK authorities should now ensure they do keep UK market interest rates around Bank rate levels, and should cut the UK bank rate. The UK version of the credit crunch was an especially unpleasant one, and was made worse by the failure of the UK monetary authorities to preserve reasonably liquid markets. In recent days the bank rate set by the Bank of England meant little, as 3 month market rates were well above it, representing a further unplanned tightening of credit.
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John Redwood has been the Member of Parliament for Wokingham since 1987. First attending Kent College, Canterbury, he graduated from Magdalen College...
The “bail out” was a shocking attack on capitalism, and sets an alarming precedent for any future difficulties that a major bank might face.
http://lettersfromatory.wordpress.com/2007/09/19/the-puppet-master/
I feel that by cutting rates the Fed may well have dealt with the short term problem of liquidity but will suffer in the long run because of the weakness of the dollar. This will surely lead to inflation, particularly if the Fed cuts again. On the UK front I feel sure that underlying inflation will surface once the pound depreciates. Therefore the BOE dare not cut interest rates, nor would Brown sanction that.
Reply: I do not agree. Yes, the dollar has weakened, but it needs to do, as the USA has to - and will -shift resources out of home consumption into exports. Inflation is under good control. There is excess supply in world manufacturing, with falling prices in many areas. House prices are falling rapidly in the USA. There can only be inflation if there is excess money over goods. The problem recently has been a shortage of money, which the Fed is now moving to ease. Inflation on the official measure in the UK is below target at 1.8%. Additional inflation in the wider RPI is coming from higher interest rates, and public sector charges.
John, do you feel the dollar could be in danger from foreign central banks offloading US treasuries? Over the last few weeks 48 billion dollars have been sold. This could have a huge impact on budget deficits. The dollar is becoming a maligned currency, which at one time was unthinkable.
Meanwhile China for its part has talked openly about ending western economic pre-eminence in the world. Recently the Chinese even went so far as to describe their accumulation of US dollars as being the equivalent of an ‘economic nuclear option’ which could decimate the US economy. So it seems the dollar is under attack from all sides. What could be the implications of a debased dollar for the global market in the long run?
Reply: There is always the possibility that large holders of dollars will wish to sell some. A very large holder like China would be unlikely to sell too much too clumsily, as they would be the main loser from too sharp a fall in the dollar. Ahead of the Olympics China is also likely to want to avoid political controversy through its actions in the markets.