Interest Rate Policy Madness

The Former Prime Minister says of Japan Should Consider Cutting Interest Rates.

The Bank of Japan should consider cutting interest rates to prevent an economic slowdown, said Heizo Takenaka, economy minister under former Prime Minister Junichiro Koizumi. Takenaka, answering audience questions after a speech in New York, said it would be "very difficult" for the central bank to maintain its policy of gradually raising interest rates, and "they have to consider an interest-rate cut again."

Japanese consumer prices are rising even as the world's second-largest economy shows signs of slowing. A report yesterday showed factory output in January slumped at twice the pace economists predicted. Japan's key interest rate is the lowest among the world's major economies at 0.5 percent.

Japan only has 50 basis points left to work with. How much more cutting can they do? Can it possibly do any good if other nations are cutting more?

Cries For Intervention As Euro Soars

The Telegraph is reporting Soaring euro threatens European jobs exodus.

The euro has surged to an all-time high of $1.51 against the dollar, prompting bitter complaints from European industry and setting off a sharp sell-off in sovereign bonds from southern states deemed least able to withstand a super-strong currency.

Germany's car-maker BMW said it was slashing 5,600 jobs and warned of more drastic action if there was a "sustained rise" in the euro above $1.50.

Charles Edelstenne, head of France's Dassault Aviation, told Le Monde that the euro's rise was reaching asphyxiation level. "We can't cope with a such an exchange gap by producing and sourcing in the eurozone.

Airbus has also drawn a line in the sand at $1.50, warning that it will have to turn its industrial structure inside out if it is to meet aircraft delivery contracts priced in dollars.

A top aide to French President Nicolas Sarkozy fired a shot across the bows of the ECB yesterday, demanding that "monetary policy must remain within reasonable bounds". The comments are a clear hint that Paris may try to force a change of tack by invoking Maastricht Article 109, which gives EU politicians the power to dictate exchange policy. France has lacked allies for use of this so-called "nuclear option", but this may change now that a number of eurozone countries are in trouble.

Spreads between 10-year German government bonds and the equivalent debt across the eurozone's Latin bloc have jumped to the highest level since the launch of EMU, reaching 45 basis points for Greece, 43 for Italy, 36 for Greece. The spreads on Spanish bonds have ballooned to 28 from 4 last May, reflecting an abrupt change in perceptions as the property boom deflates and investors take a closer look at Spain's current account deficit, now a 10pc of GDP.

"The widening spreads are telling us that these countries are going to be hit harder than core Europe in a downturn," said Simon Derrick, head of currency research at Bank of New York Mellon.

Hans Redeker, currrency chief at BNP Paribas, said foreigner investors had largely stopped buying euro-zone bonds, suggesting that the euro rally is now on its last legs. The inflow is mostly "hot money" speculation.

Mr Redeker said there may soon come a point when the ECB's ultra-hawkish turns negative for the euro, causing traders to look beyond instant yield and focus on the risk that monetary overkill could tip the bloc into a deep downturn.

The ECB Will Cut

The ECB will cut or the market or politicians will force it to. Heaven help the Eurozone if politicians wrest control of the process.

The Fed Will Cut Now, Worry About Inflation Later

Charles Plosser, president of the Philadelphia Fed, says Economy trumps inflation.

In a speech delivered to the National Association for Business Economics in Washington, the president of the Philadelphia Federal Reserve, Charles I. Plosser, said inflationary worries can be put aside in certain unique situations.

"I believe we are in a situation where monetary policy cannot be made by focusing solely on inflation," Plosser said. "The current turmoil in financial markets has already had a significant impact on the economy and has the potential to continue to restrain economic growth going forward."

But Plosser said that once the markets turn around, significant action needs to be taken to stem the tide of inflation.

"Such deviations should be temporary and limited and promptly reversed when conditions return to normal," Plosser said.

50 Basis Point Cut Baked Into Cake

Check Out The March Probability Curve



click on chart for sharper image
Chart courtesy of the Cleveland Fed

The current Fed Funds rate is 3.00% but the odds of a cut all the way to 2.00% are actually higher than a cut to 2.25%. That's pretty wild.

Canada Cuts Rates A Half Point

The economic slowdown in the US has solidly hit Canada. Canada Cuts Rate a Half Point, Signals More Is Needed.

The Bank of Canada cut its benchmark interest rate a half point, the first such move since 2001, and signaled it will have to act again to offset a slump in exports to the U.S.

Mark Carney, in his first decision as governor, cut the target rate for overnight loans between commercial banks to 3.5 percent, the lowest since March 2006. Thirteen of 26 economists surveyed by Bloomberg News predicted the move.

"Further monetary stimulus is likely to be required in the near term," the central bank said today in a statement from Ottawa. Signs of economic slowdown in Canada are "materializing and, in some respects, intensifying."

Tumbling exports to the U.S. will limit 2008 economic growth to a seven-year low of 1.8 percent, the central bank says, and have erased the country's broad trade surplus for the first time since 1999. The bigger rate cut today also helps catch up with moves this year by the U.S. Federal Reserve, and may slow the Canadian dollar's advance that has battered manufacturers.

"There are clear signs that the U.S. economy is likely to experience a deeper and more prolonged slowdown than had been projected," which will have "significant spillover effects on the global economy," the Bank of Canada said today.

There are still signs that consumer prices might pick up again. Canada's jobless rate is at a 33-year low, wages are rising at the fastest pace in a decade, and companies are earning record profits.

Financial Winter

Ambrose Evans-Pritchard is writing The Federal Reserve's rescue has failed.

The verdict is in. The Fed's emergency rate cuts in January have failed to halt the downward spiral towards a full-blown debt deflation. Much more drastic action will be needed. Yields on two-year US Treasuries plummeted to 1.63pc on Friday in a flight to safety, foretelling financial winter.

The debt markets are freezing ever deeper, a full eight months into the crunch. Contagion is spreading into the safest pockets of the US credit universe.

It is hard to imagine a more plain-vanilla outfit than the Port Authority of New York and New Jersey, which manages bridges, bus terminals, and airports.

The authority is a public body, backed by the two states. Yet it had to pay 20pc rates in February after the near closure of the $330bn (£166m) "term-auction" market. It had originally expected to pay 4.3pc, but that was aeons ago in financial time.

"I never thought I would see anything like this in my life," said James Steele, an HSBC economist in New York.

As the once unthinkable unfolds, the leaders of global finance dither. The Europeans are frozen in the headlights: trembling before a false inflation; cowed by an atavistic Bundesbank; waiting passively for the Atlantic storm to hit.

The euro fetches $1.52 (from $0.82 in 2000), beyond the pain threshold for aircraft, cars, luxury goods and textiles. The manufacturing base of southern Europe is largely below water. As Le Figaro wrote last week, the survival of monetary union is in doubt. Yet still, the ECB waits; still the German-bloc governors breathe fire about inflation.

The Fed is now singing from a different hymn book, warning of the "possibility of some very unfavourable outcomes". Inflation is not one of them.

"There probably will be some bank failures," said Ben Bernanke. He knows perfectly well that the US price spike is a bogus scare, the tail-end of a food and fuel shock.

The greater risk is slump, says Princetown Professor Paul Krugman. "The Fed is studying the Japanese experience with zero rates very closely. The problem is that if they want to cut rates as aggressively as they did in the early 1990s and 2001, they have to go below zero."

Section 13 of the Federal Reserve Act allows the bank - in "exigent circumstances" - to lend money to anybody, and take upon itself the credit risk. It has not done so since the 1930s.

"We are becoming increasingly concerned that the authorities in the world do not get it," said Bernard Connolly, global strategist at Banque AIG.

"The extent of de-leveraging involves a wholesale destruction of credit. The risk is that the 'shadow banking system' completely collapses," he said.

For the first time since this Greek tragedy began, I am now really frightened.

Economic Madness

The madness in all of this is that every economic policy maker is guessing what to do. It's fairly safe to say that Japan cutting rates to zero is probably a bad policy decision. But what about actions by the ECB or the Fed? Is anyone certain what to do?

I agree with Ambrose Evans-Pritchard that the ECB is "trembling before a false inflation". Anyone seeing inflation in either the US or EU simply does not know what inflation is.

However, we are in this mess because of central bank policies worldwide have purposely fostered inflation. Those policies "work" until they don't. We are now on the back side of a credit crunch unlike anything we have seen since the great depression.

And unlike 1930 there are far more variables such as global wage arbitrage, emerging markets, massive resource consumption India and China, global property bubbles, and peak oil. There is no way the Fed or the ECB can factor in all those variables, each of which changes dynamically every day.

Furthermore neither US or EU policy can be set in a vacuum. What the US does may influence the correct course of action elsewhere. We're all related now.

Everyone Is Guessing

The proper course of action may (or may not) be for the the ECB to cut. On the other hand, the US may (or may not) have already done everything that can possibly be done already (and then some). Canada is facing shrinking exports to the US but a jobless rate at a 33 year low. What's the right decision here? The answer might not be apparent until the Canadian property bubble busts for good.

It's time to face the facts: Central banks are guessing. In many cases it look like "panic guessing". However, the facts remain that the Fed, the ECB, and the Bank of Canada do not know where interest rates should be any more than they know what the price of orange juice should be. After all, it was the Fed slashing rates to 1% that created much of this mess. It is now widely understood, just how bad that decision was.

If the Fed proposed tomorrow to fix the price of orange juice, everyone would think they were mad. Ironically, the vast majority sees nothing wrong with price fixing interest rates, even though it is clearly proven the Fed has no idea what it is doing. Consecutive bubble blowing is proof.

The sad thing in all of this is there is no need for guessing. We would not be in this mess if there was no Fed and there was no such thing as fractional reserve lending.

It's time to eliminate interest rate and currency madness. The way to do that is to abolish the Fed specifically, central bankers in general, and fractional reserve lending right along with them. Sound money and sound monetary policy is the solution, not price fixing. Price fixing interest rates rates and currency manipulation got us into this mess, it will not get us out of it.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List