The Finance Markets, Which Central Bank is Right

With the three major Western currency blocs acting in different ways to the current fiscal, growth and inflationary problems it will be educational to look back and analyse which was correct. One Bank has been slashing rates, one holding steady and the third looking to tighten spending.

With Federal Reserve rates around 2%, about half the inflation rate, we can see that the Fed is more concerned with growth than with fighting inflation. For holders of cash and short term bonds the decay in the absolute value of your assets is running (after tax on income) at around 2.5% a year. This slow but constant devaluation of overall net worth is now affecting just about every single asset class in America. With the ongoing USD weakness it is not unreasonable to assume the average American citizen is significantly poorer this year than last.

To be fair, the US is, by and large, pretty insular economically, socially and politically. In such an economy the affects of such a damaging raft of conjoining events can be mitigated to a certain extent. However, in the end, the general decay of personal spending power in global terms must start to affect overall growth.

In the UK the Bank of England is taking a different line, one of passivity, neither trying to fight inflation aggressively nor attempting to boost growth. The Treasury and Bank seem to be following a “Let’s Wait and See” plan. If banking crisis knee jerk reactions are almost certainly the wrong ones this amazing inactivity may eventually prove to be the correct path to follow. Having said that it does appear sometimes that Mervyn King is doing little while Rome burns.

The European Central Bank. The uber hawks. Jean-Claude Trichet et al seem content to throw entire economies to the wall in their never ending search for 0% inflation. Much is written about the events in Frankfurt contributing to a possible break up of the Euro but the currency is now so imbedded into the various Eurozone economies that it would be virtually impossible, now, to break out. As Simon Denom of Capital Spreads put it, “For all of the fulminating of the Mediterranean members over the current intractability of the central bank and the loud threats of ‘I can always leave if I want to’ the simple fact is they made their bed in the late ‘90s. Now they must lie in it”. The one thing that might be up for grabs is the independence of the ECB itself if enough countries become frustrated with the banks policies. However if this was likely then the Germans might well pick up their ball and leave the game. The Germans, uniquely in the European arena, have been through not one but two bouts of hyper inflation in the last 80 or so years. The first, it can be argued, created the conditions for dictatorship and the second smashed savings by about 90%. It is this albeit fading memory that drives the German fear of political influence in macro financial affairs. And it is this phobia which appears to be the overall driving force behind the ECB thinking.

But which of these three policies will work and which will be taught in schools? Personally I believe that, within reason, all three will probably end up with pretty much the same result as the influences on all the Western nations are to a great extent not internal but external. Underlying commodity prices are the driving factor in much of the inflation bubble and a growing economic power in the East is causing ever higher wealth transfer out of the west. The major internal factor is the current financial sector woes which can all be sourced from the same problem of over-inflated property values. As with all valuations this will probably swing from ridiculously over priced to bizarrely cheap over the next two or three years and nothing that any central bank does will, in the end, have made a blind bit of difference.

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