Three cheers for the Fed – “I see no recession”

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.

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  1. APL
    January 23, 2008

    JR: "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."

    The problem with this is that by cutting rates the US have indicated they are prepared to sacrifice the US$. When that reality filters through to the holders of US assets like the Chineese government and even the European Union, there will be a scramble to exit those assets which will probably make the US$ value drop faster.

    Given that the US$ will no longer be as desirable as it once was, who will buy all the US government bonds, purchase of which have propped up the US governments domestic spending this last decade? Who in their right mind would buy a depreciating asset on the way down?

    The US government have a dilemma, prop up the US economy and destroy the US$, or prop up the US$ and destroy the US economy.

    Our glorious leader, Brown who was so proud of his sale of the British Gold reserves will find that just as we need the 40% of value of the gold we exchanged for US$ they will be worthless.

    What a financial and intellectual genius that man is.
    Two books on courage and absolutly no backbone!

  2. Neil Craig
    January 23, 2008

    The problem is that monetary policy can smooth out the business cycle but only microeconomic policy (planning regulations, health & safety bureaucracy, corporation tax & business rates, x-prizes, regulations limiting new technology like GM & the amount of GNP spent by non-productive parts of government) can, in the end, alter the underlying trend. For these reasons our underlying trend is that growth is half the world average.

  3. newmania
    January 23, 2008

    Our public debt is proportionally worse than the US according to Irwin Selzer but theirs is still unhealthy. The idea that reducing taxes increases tax yield is not proven it seems to me although one can see that it must do in some sense. The tax on business should of course be put back as it was but as to whether a further decisive re-allignment of the balance can be achieved right now …not sure

    Still about time we had some choppy waters , tends to clean out the political closet a bit

  4. Tony Makara
    January 23, 2008

    I still feel it a dangerous policy for the Fed to make such sweeping cuts with the dollar already being so weak. This is a classic inflationary formula and very worrying that there is talk of a further cut next week. America is going to have stagflation because the question of liquidity is one of trust and trust cannot be mechanically generated by cutting interest rates.

    On a somewhat related matter the Chinese today seem ready to control their overheating economy with a prices and incomes policy as this comment today makes clear:

    "the central government decided to launch a number of temporary interventionist measures to control prices, and implement a more aggressive monetary policy to curb inflation in 2008."

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