Sunday, December 23, 2007

1929 "a walk in the park"

Reflecting our gloom in the previous post (see last paragraph) Ambrose Evans-Pritchard writes in the business section of The Sunday Telegraph that the central banks are failing in their attempts to stave off a depression and that "things are rapidly spiralling out of their control".

To emphasise how close to the precipice we really are, Ambrose cites York professor Peter Spencer, chief economist for the ITEM Club, who says the global authorities have just weeks to get the situation under control. If they do not, says Spencer, "this could make 1929 look like a walk in the park."

One of those central banks, however, is the European Central Bank, custodian of the euro. It - together with the Bank of England and the Federal Reserve Bank – are, according to "a chorus of economists" fighting the wrong war, and perhaps risk a policy error of epochal proportions.

In graphic prose, Ambrose describes how the central banks are caught between the Scylla of the debt crunch and the Charybdis of inflation, needing on the one hand to ease lending rates to encourage lending and, on the other hand, to increase rates to damp down spending.

What is most worrying though is a comment from Bernard Connolly, now global strategist at Banque AIG, who says, "The central banks are trying to dissociate financial problems from the real economy. They are pushing the world nearer and nearer to the edge of depression…".

That is indeed the impression many commentators get. There is an air an unreality about the growing crisis, and it is not only the central banks. At one, we see Brown still parading his "economic competence" and preening that the UK's economy is strong. Then we see the population is still rushing out to float Christmas festivities on a sea of debt. But all the while, the whole economic system seems to be sliding into the abyss.

When Tim Congdon says that the rot has seeped through the foundations of British lending, it really is time to get worried.

But, if the UK has problems, so does the ECB. Inflation is 3.1 percent, the highest since monetary union, enough writes Ambrose, to set off a political storm in Germany. He tells of a Dresdner poll which found that 71 percent of German women want the Deutschmark restored.

Frankfurt, therefore, cannot easily cut rates to cushion the blow as housing bubbles pop across southern Europe. Instead, it is having to resort to "tricks", hence its rush to increase liquidity on the money markets.

This is also to disguise the "ECB's little secret". It must never allow a Northern Rock failure in the eurozone as this would expose the reality that there is no EU treasury and no EU lender of last resort behind the system. Writes Ambrose:

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.
And that is another worrying factor. When or if a major economic crisis arrives (if it has not already), the euro is yet another uncertain factor in the mix.

Untried and untested in any crisis, the ECB is having to serve many masters, yet having feet of clay, it will be fighting for its own survival when all its focus and efforts will need to be on working with the other banks to ensure the survival of the global economic system.

That, in the final analysis, may be the ultimate penalty for the Europeans' hubris. Having destroyed the financial systems of the eurozone member states, they have not yet devised instruments which are capable of taking up the slack. In or out of the euro, we may all have cause to regret that.


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