Wednesday, October 8, 2008 1 comments ++[ CLICK TO COMMENT ]++

Rate Cuts Are a Mistake

Several key central banks of the world cut interest rates today in a co-ordinated move, attempting to combat the financial crisis.

Central banks in Canada, the United States, Britain, the European Union, Sweden and Switzerland cut key lending rates by half a percentage point. China's central bank joined in by cutting its key interest rates 27 basis points as of Thursday.

Only Japan, among the major central banks, opted out, since its rates are already at a rock bottom 0.5 per cent.

This is a mistake in my opinion. EU and several others can cut rates (they haven't cut much in the last year and are thought to be running a somewhat tight policy) but the FedRes and the Canadian central bank should not be cutting. Paul Krugman approves of the cut--I don't--but still mentions how commercial paper rates have not moved much in the last year even though short-term central bank rates are much lower. This basically means that the rates aren't really flowing through to the end-user, or the economy in general. So a cynic might say that the whole point here is to increase the profit spread for banks (this involves extracting wealth from savers) but I don't think even this is going to work.

Not only does the Federal Reserve lose future ammunition, this is setting up the stage for a potential inflation problem. Yes, no one talks inflation these days but the recent actions are leading me to towards that stance. I have always been in the disinflation/deflation camp for the last 3 or 4 years--otherwise I would never have been bearish on commodities--but the current central bank moves are finally sowing the seeds of inflation.

Before anyone forgets, recall that the super-low 1% interest rates in the US in 2003 was one of the reasons we find ourselves in the current mess with housing.

Tags: ,

1 Response to Rate Cuts Are a Mistake

October 9, 2008 at 8:15 AM

Bush & Co. wanted to get "confidence" back in the credit market. Since the professionals know how bad things are*, they appealed to retail. Retail (aka voters) don't know TAF/TSLF/TARP etc. but they know lower interest rates are better (since they are borrowers and not savers).

* TED spread up today by 18 bps

Right or not, Paulson's sneakly plan to inject capital into banks will likely help. How they do it will be interesting. They could wipe a lot of market cap ala FRE/FNM.

Post a Comment