On to Moscow!
Last week, the European Central Bank squared its shoulders and joined ranks of the damned. The Times of London reported that in joining up with the US Federal Reserve Bank and the Bank of England, the European Central Bank “pulled out all the stops” in their drive to revive their economies. The ECB announced that it will cut its key lending rate to its lowest level ever and begin a form of “quantitative easing,” in which it will buy corporate debt in order to reduce commercial interest rates. Details to follow, it said. “Stops” are to central bankers what safety fuses are to electricians. You may take them out when you really want to get the juice flowing; but your house might burn down.
But thus did the European troops pull out the stops and get under-way. Reluctant allies, they set off to join the battle against capitalism…with no reliable maps…with insufficient supplies and a strategy elaborated by incompetents. Of course, the gods must have laughed at Napoleon too. His armies had been cut off and destroyed in Egypt. Then, his Peninsular Campaign was a disaster. But the plan to attack Russia topped them all; even the draft horses must have snickered.
It doesn’t seem to bother the Europeans that their American commander is the same fellow who failed to spot the biggest bubble in history until it blew up in his face. Nor that their field marshal has no idea of the lay of the land; nor that anyone on either side of the Atlantic seems to know where they are going; nor that, wherever it is, it will cost more to get there than they’ve got.
This week the Obama government revealed its new budget deficit. If nothing goes wrong, it will reach $1.84 trillion this year – nearly 400% of the record set last year. In 2009, the US government will borrow 50 cents for every dollar it spends. Accumulated deficits to 2019 will reach $7.1 trillion, says the forecast. Moody’s was so alarmed it warned that the US may lose its Triple-A bond rating, which it has had since 1917.
But even as bad as it looks, Obama’s budget map is still fanciful – its mountains are made of whipped cream and its rivers run with Scotch. It imagines a loss of only 1.2% of GDP in the current downturn…and a quick return to growth, with a 3% increase in 2010. Yet, the last report showed the US economy contracting at a 6% annual rate. As for growth in 2010…where would it come from? Consumer credit is falling at its fastest pace in 18 years. Consumer incomes are falling too – down 1.2% in the last 12 months. If there were any lasting consequences of this downturn, opines the New York Times, it is likely to be the “shift to savings” by the US consumer.
Meanwhile, businesses aren’t exactly hankering to spend either. Even if they had the money, businesses wouldn’t expand; they don’t have to. Spiders build their webs on America’s remaining assembly lines with little risk of being disturbed; one out of every three factories is quiet. Until existing capacity is put to work, businesses will have no power to raise prices and no need to add to their facilities.
And yet, Napoleon Bernanke is upbeat. The troops will be home “before Christmas,” he says. But the central banks’ calendars are no better than their maps. In 2004, Mr. Bernanke credited improved monetary policy with having created what he called “the Great Moderation” – the period of strong growth and low-inflation since the mid-’80s. Specifically, he was referring to the Fed’s policy of ‘inflation targeting,’ which presumes that the inflation numbers carry all the information the Fed needs to guide an economy.
This was the map the Fed was using seven years ago. Then, a tiny recession took GDP down to all of 0.2% over an 8-month period. The Fed panicked. Its emergency policy pushed the fed funds rate well below the rate of consumer price inflation and left it there for two years. This was not merely a slight miscalculation. It was a fatal strategic error, say professors Carr and Beese of the University of Akron. Not only did the Fed’s map fail to warn them; it actually sent the economy over a cliff:
The low interest rates signaled…that credit was inexpensive and readily available…[then] the Federal Reserve moved from a low accommodative interest rate policy to one of a steady and consistent increasing of interest rates between 2004 and 2007…and became a prime cause of the financial services mortgage crisis of 2008.
Today, central banks use the same computers, same theories, and same maps they had seven years ago. With these feeble instruments, they set out to go where no central bank has ever gone before – borrowing, inflating, and intervening on a scale that would have been unimaginable a few years ago. Where will they end up?
We will take a guess: this grande armee sets off on the road to recovery with the wind at its back; it will end up in Moscow with snow on its face.
Enjoy your weekend,
The Daily Reckoning