The Hindu Business Line : Rate cuts, liquidity leave credit markets cold

Central banks all over the world are slashing interest rates as never before. America’s interest rate setting body, the Federal Open Market Committee (FOMC), is expected to cut further from an already historic low of 1 per cent before this appears in print.

Just days ago, the ECB brought rates down to 2.5 per cent and the Bank of England to 2 per cent — Britain’s hasn’t been so low in living memory — and Japan at 0.3 per cent, is close to zero, in which direction the US too now seems to be heading.

Yet, thus far, credit markets are reacting with a yawn. Central banks are pushing unlimited liquidity into markets, but it is simply being pushed back.

Banks are yet to say finis to write offs, mark-to-market and provisioning. No one still knows the final bill.

Until then, the name of the game is to bolster capital and stay liquid. New lending is the last thing they want to do.

At other times, such sharp rate cuts would have boosted asset prices.

The US housing sector was, after all, the beneficiary of prolonged low interest rates in the early years of this decade.

So bad, however, are economic conditions — jobs, consumer and business spending and confidence — that house prices continue to fall amidst the lowest interest rates in decades.

What happens when we reach the end of the road on rate cuts? We are practically in zero territory.

If this doesn’t work, what will?

Economists have a name for this — the ‘liquidity trap’. We are in the thick of one now.

Next step

The US Fed Chairman, Mr Ben Bernanke, is not twiddling his thumbs.

The next step is ‘quantitative easing’, which means the Fed intensifies its money-creating and injecting actions.

In fact, the process started some time ago when it decided to waive collateral quality requirements in its funding operations with commercial banks.

It has also been buying commercial paper, stepping into the shoes of banks and financing businesses directly. All these are unprecedented steps for a central bank.

Only a lasting revival of economic, business and consumer sentiment and activity would halt asset price haemorrhaging. Monetary policy has been unable to accomplish this.

So the buck now moves to President-elect Barack Obama. He has assembled a brilliant economic team.

They know it is time for aggressive fiscal measures, which means massive government spending. Figures of a trillion dollars are being bandied about to get the wheels moving with minimum loss of time.

The emphasis, rightly, is not on passive tax cuts but a job-creating stimulus, putting money in the pockets of the needy, throwing inflation and deficit fears to the winds.

It is our best hope yet.

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