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Wednesday October 8, 2008 - 15:48:05 GMT
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Central Banks Get Out The Butcher’s Knives

Key News
• Yen Rises to Three-Year High on Concern Interest-Rate Cuts May Fall Short (Bloomberg)
• Pending Home Resales in U.S. Increase 7.4% as Foreclosures Reduce Prices  (Bloomberg)
• British Banks Get $87 Billion Government Lifeline to Save Financial System (Bloomberg)

“The avowed mystics held the arbitrary, unaccountable “will of God” as the standard of the good and as the validation of their ethics. The neomystics replaced it with “the good of society,” thus collapsing into the circularity of a definition such as “the standard of the good is that which is good of society.” This meant, in logic – and, today, in worldwide practice – that “society” stands above any principles of ethics, since it is the source, standard and criterion of ethics, since “the good” is whatever it wills, whatever it happens to assert as its own welfare and pleasure. This meant that “society” may do anything it pleases, since “the good” is whatever it chooses to do because it chooses to do it. And – since there is no such entity as “society,” since society is only a number of individual men – this meant that some men (the majority or any gang that claims to be its spokesman) are ethically entitled to pursue any whims (or any atrocities) they desire to pursue, while other men are ethically obliged to spend their lives in the service of that gang’s desires.”

          Ayn Rand

FX Trading – Central Banks Get Out The Butcher’s Knives

The Federal Reserve cut their benchmark interest rate by 50 basis points today.

And so did the European Central Bank ...

And so did the Swedish Riksbank ...

And so did the Bank of England ...

And so did the Bank of Canada …

There’s decent chance this caught a bunch of people off guard. And there’s probably an even greater chance market players didn’t know how to react.

We were seeing crazy moves this morning; quotes were jumping like 5 and 10 PIPs at a time, back and forth. Not to mention the pack of majors was fairly mixed versus the dollar. The euro and Swiss were stronger, the Comdols much, much weaker. The yen was up big.

The tide began shifting mostly in the dollar’s favor, but things were shook up again and the currencies remain mixed. It’s kind of a wait-and-see game now in the wake of this interest rate action.

To the specific point we’ve mentioned plenty of times in the last couple months ... the Federal Reserve is ahead of the curve on interest rates. It seems likely to us they have less distance to travel on the downside with policy rates.

Major central banks around the world, on the other hand, have quite a bit of room to play with. Ultimately, the potential for rates to still drop a lot further in European and Antipodean countries will sustain the exchange-rate rebalance that’s currently working to the advantage of the greenback.

So if you’re seeing Fed rate cuts and automatically thinking the US dollar will fall, you might want to get your brain off cruise control. There are too many other factors that are going to keep the rates-vs.-currency trend turned upside down.

Are Interest Rates Too Low?

The argument for central banks and the government’s economic officials during this time of crisis goes like this:

Individuals, companies and banks are having trouble accessing credit. This inability to secure credit is wreaking havoc on the growth of the economy. By cutting interest rates, credit is made cheaper and encourages borrowing that will in turn stabilize growth.

Well, in reality it’s not quite that easy and obvious. The government’s solution is a lot like a Marathon runner fueling his body with cotton candy ...

The runner may get quite a burst of energy from the cotton candy at first, but sooner or later his sugar-drive is going to peak and subsequently collapse. And in an effort to keep from losing his sugar-drive completely, the runner just takes in more and more cotton candy. The problem is, the cotton candy intake becomes increasingly less effective and actually becomes unhealthy.

But you say, how could allowing cheaper access to credit, at a time when it’s “completely necessary” for the economy to function, become unhealthy for the economy? My answer ...

It’s not completely necessary. The problem, as many have already mentioned, is a lack of confidence in the lending system. To a much smaller extent is the problem actually due to a lack of credit.

Easy access to credit -- unnecessarily low interest rates and a loans-for-everyone mentality among banks, for starters – is what created the bursting bubble we’re “reacting” to right now. Cheap money and easy access to loans has bred projects of lesser value and less profitability than would have money that’s a bit more difficult and costly to secure. Artificially low rates attract any ol’ Joe Schmoe who’s got a business idea – no matter if it’s building birdhouses out of popsicle sticks or selling cell phones to scuba divers. Market determined interest rates, however, naturally weed out the birth of wasteful and absurd projects.

Surprisingly and fortunately, though, quite a few parties are learning lessons from excessive intake of credit. They’re not feeling so good anymore. And they’re not willing to swallow any more cotton-candy credit no matter how cheap and how easily accessible it becomes.

What needs to happen is a period of cleansing and consolidation. Particularly with the banks, everyone needs to know which banks are solvent and which ones are being held together with paper clips and chewing gum. The collapsing banks will need to liquidate. The solvent banks will be able to buy up assets on the cheap and solidify their own business. The result is a more healthy entity that’s ready to run.

The cotton-candy credit being dished out is going to buttress the paper clips and chewing gum for a little while longer, sure. But that’s only going to delay the inevitable collapse of these institutions and fail to restore confidence that some banks who will actually escape this mess willing to lend and borrow between one another at healthy, responsible rates.


Black Swan Capital


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