Three cheers for the Fed. One cheer for each 25 basis point cuts in interest rates announced as an emergency measure yesterday. It did the trick, limiting the savage market decline, and turning round the Asian markets which had been in freefall the previous day.
The US authorities have made it clear to the markets that they are going to stop a recession if it is in their power to do so. They have made aggressive moves in reducing interest rates. This will help a great deal. It means that many mortgage holders and companies in debt will now be able to afford their interest payments and repayments, improving the quality of the loan assets on the balance sheets of the banks and those held in securitised form. It means that all those financial companies that have borrowed so much to sustain the easy credit of earlier years will also have some relief on the amounts they have to pay in interest. The whole financial structure in the US is a little less unstable as a result of this development.
As I argued yesterday, two conditions need to be fulfilled for recovery to get underway. The first is lower interest rates. The second is the recapitalisation of the banks, so they have the stronger balance sheets they are going to need to lend people and companies more money again. This process can happen by the passage of time, as they trade profitably. It can be speeded up by cutting or cancelling dividend payments, or by raising new money from shareholders.
The gyrations of world markets in the last few days shows that the Indian, Chinese and Japanese markets are still very influenced by perceptions of the state of the US economy. All three are important exporters to the USA and are influenced to some extent by US conditions. The internal strength of the Indian and Chinese economies is becoming more obvious, but it is not thought sufficient to offset the full blown US recession which some market participants feared.
The Governor of the Bank of Englands remarks showed how far behind the plot the UK now is. The worse circumstances of the UK economy as a result of recent policy are now dragging it down relative to the US and the Asian giants. As the Governor pointed out, we have a bad inflation problem this winter. The governments own borrowing requirement was far too large before Northern Rock hit, only to be made far worse by the Northern Rock debacle. The big build up in UK public spending and borrowing, and the poor productivity of the enlarged public sector, all limit the UKs room for manoeuvre, at a time when the UK too needs lower interest rates to relive pressure on its financial system. The government is trying to control public spending at last by clumsy interventions on public sector pay, but still lacks a grip on large projects and staff numbers.
A recession can be averted in the US. The UK will experience a sharp slowdown, which will be made worse if the Chancellor presses on with plans to increase capital gains tax on entrepreneurs and with damaging plans to tax non doms too much.