If markets are
forced to choose between a known negative and an uncertainty they will favor the
debacle and its dire effect on the American financial system have been on full
display for more than a year. The attempts of the Federal Government and private
investment to deal with the multiplying bank and credit problems are daily
headlines. Yet as the crisis has worsened the US Dollar has begun a steady climb
against its main competitor the euro. At the end of one of the most tumultuous
weeks in American economic history the dollar had regained 85% of the ground it
had lost since the credit crisis began in August 2007. Overall the dollar has
added almost 15% to its value against the euro since July 15 of this year when
it hit bottom.
credit and consumer problems in Europe have only begun to damage the European
economy. The fear is that there is much more to uncover. The insouciant attitude
of some official European figures has not allayed market concern that European
officialdom is complacent about the credit meltdown. Comments from Christian
Noyer the Governor of the Bank of France â€śthat there is no drama in front of usâ€ť
and from Peer Steinbruck the German Finance Minister that the US was â€śthe source
â€¦and the focus of the crisisâ€ť, seemed detached from reality. Within days the
German government was forced to arrange a 35 billion euro loan to salvage Hypo
Real Estate the countryâ€™s second largest property lender. Authorities in
Belgium, Luxembourg, the Netherlands, Britain, France, Germany and Iceland have
been forced to rescue or recapitalize institutions operating within their
borders. The credit crisis suddenly seems very European.
And then there is
the European Central Bank (ECB). Jean Claude Trichet, the President, and the
governing board have apparently realized that the European Monetary Union (EMU)
has an economic growth problem and perhaps even a credit problem. At Thursdayâ€™s
news conference after the board had left the rate unchanged at 4.25%, he said
that the board had only considered two options, a rate cut or a hold and the
vote for the hold had been unanimous. But his emphasis on the economic situation
in the news conference afterward make it very likely that the board will cut
rates at their next meeting or s sooner perhaps in a coordinated effort with
central banks around the world.
inherent in a united monetary policy supported by fifteen different fiscal and
tax policies answering to fifteen political regimes is about to be put to the
test in the EMU.
In Ireland and
Greece depositor withdrawals forced the government authorities to guarantee all
bank deposits regardless of size. These moves infuriated other European banks
who feared a run on their own deposits by customers seeking security. In the
shaky condition of many banks, unable to borrow in the credit markets and
harboring questionable securities on their books, a run on deposits could be
disastrous. Regulators and government officials in several European countries
were inundated with worried calls from bankers who feared the loss of their
deposits. But the deposit guarantees in Ireland and Greece stand and illustrate
the difficulty of a coordinated policy response to the credit crisis among
fifteen national governments that have only one executive agency in common, the
ECB, and only one policy under its control, monetary.
of France proposed a 300 billion euro bailout fund that was promptly denied by
Germany. He did however manage to convince Angela Merkel of Germany, Gordon
Brown of Britain, Silvio Berlusconi of Italy, Jean Claude Juncker of Luxembourg
to meet with him and the Jose Manuel Barroso the European Commission Chairman
and Mr. Trichet the head of the ECB, in Paris to formulate an EU response to the
crisis. But with German opposition to a bailout fund, the meeting will probably
not go far beyond its official task of agreeing on plans for stricter investment
bank regulation to be put before the next G8 summit.
have two problems in relation to the credit crisis and the impending recession.
The ECB has kept its base rate at 4.25% too long and is far behind the curve in
an economy that is or soon will be desperate for liquidity and credit. It is no
doubt true that inflation will take some time to descend to the ECB 2.0% target.
In the current economic environment that is irrelevant. This crisis has moved
much faster and spread much farther than the ECB anticipated. At this point even
a steady series of rate reductions could take a year or more to reach US levels.
The credit contraction will soon start to bite in the productive economy and the
ECB will be hard pressed to provide a timely rate stimulus.
US authorities have concluded the credit problems are
systemic and the best solution treats the whole rather than the separate failing
institutions. In the US that is relatively easy, once the political side it
motivated. In Europe a coordinated response may be hard to formulate and harder
to implement. The piecemeal reply to failing markets will delay recovery and by
concealing until the last minute weak institutions, foster fear about the safety
of even quality institutions. The more uncertainty there is about the health of
Europeâ€™s financial institutions the greater the perceived damage. In a troubled
environment uncertainty breeds panic and uncertainty will keep the euro on the
defensive until the credit crisis abates.