Twenty billion dollars here, $20bn there, and a lush half-trillion
from the European Central Bank at give-away rates for Christmas.
Buckets of liquidity are being splashed over the North Atlantic
banking system, so far with meagre or fleeting effects.
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The financial outlook in 2008: Experts' predictions
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.
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Faces of power: The Fed’s Ben Bernanke, the BoE’s
Mervyn King, the ECB’s Jean-Claude Trichet
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"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.
"It cannot deal with the underlying fear that lots of firms
are going bankrupt. The banks and the hedge funds have not fully
acknowledged who is in trouble. That is the critical issue,"
she adds.
Lenders are hoarding the cash, shunning peers as if all were
sub-prime lepers. Spreads on three-month Euribor and Libor - the
interbank rates used to price contracts and Club Med mortgages - are
stuck at 80 basis points even after the latest blitz. The monetary
screw has tightened by default.
York professor Peter Spencer, chief economist for the ITEM Club,
says the global authorities have just weeks to get this right, or
trigger disaster.
"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," he says.
"They 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," he adds.
The Bank of England knows the risk. Markets director Paul Tucker
says the crisis has moved beyond the collapse of mortgage
securities, and is now eating into the bedrock of banking capital.
"We must try to avoid the vicious circle in which tighter
liquidity conditions, lower asset values, impaired capital
resources, reduced credit supply, and slower aggregate demand feed
back on each other," he says.
New York's Federal Reserve chief Tim Geithner echoed the
words, warning of an "adverse self-reinforcing dynamic",
banker-speak for a downward spiral. The Fed has broken decades of
practice by inviting all US depositary banks to its lending window,
bringing dodgy mortgage securities as collateral.
Quietly, insiders are perusing an obscure paper by Fed staffers
David Small and Jim Clouse. It explores what can be done under the
Federal Reserve Act when all else fails.
Section 13 (3) allows the Fed to take emergency action when banks
become "unwilling or very reluctant to provide credit". A
vote by five governors can - in "exigent circumstances" -
authorise the bank to lend money to anybody, and take upon itself
the credit risk. This clause has not been evoked since the Slump.
Yet still the central banks shrink from seriously grasping the
rate-cut nettle. Understandably so. They are caught between the
Scylla of the debt crunch and the Charybdis of inflation. It is not
yet certain which is the more powerful force.
America's headline CPI screamed to 4.3 per cent in November.
This may be a rogue figure, the tail effects of an oil, commodity,
and food price spike. If so, the Fed missed its chance months ago to
prepare the markets for such a case. It is now stymied.
This has eerie echoes of Japan in late-1990, when inflation rose
to 4 per cent on a mini price-surge across Asia. As the Bank of
Japan fretted about an inflation scare, the country's financial
system tipped into the abyss.
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