WASHINGTON — Recent turbulence on global financial markets suggests that central bankers’ assurances about the credit crisis perhaps underestimated the scope of the problem.
World stock markets seesawed violently last week: While the Dow Jones Industrial Average cut its losses last Friday,closing 0.23 per cent lower after Federal Reserve interventions, other stock markets landed in the mud.
London’s FTSE 100 plunged 3.71 per cent, the CAC 40 in Paris dropped 3.13 per cent and any news of the United States’ subprime mortgage crisis, which has begun to contaminate the world economy, sent investors running for the hills.
However, earlier last week, economic leaders had offered reassuring words to calm the markets. Last Tuesday, the Fed issued a statement that took note of the “volatile” markets, but warned inflation remained its top risk for the world’s biggest economy.
The previous week, the president of the European Central Bank, Mr Jean-Claude Trichet, said the market volatility “can be interpreted as a phenomenon of normalisation of risk pricing”.
US Treasury Secretary Henry Paulson echoed that tone, stressing the health of the economy and saying “risk is being repriced”.
“For the moment, a change in monetary policies seems unlikely because the central banks view the tensions as temporary, and above all not private-sector financial problems,” analysts at French investment bank Natixis wrote last Friday in a note to clients.
In a matter of days, however, a “normalisation of risk pricing” turned into panic, forcing the central banks to massively intervene, injecting liquidity into the markets.
For economist Frederic Dickson, of DA Davidson, the combined actions “triggered heavy selling in the equity markets as traders interpreted these actions as a tacit admission that the current credit crisis is more severe than previously perceived, and threatens the economic expansion in the US and European countries”.
And their interventions still may not be enough: The markets are clamouring for Fed chairman Ben Bernanke to cut interest rates. The Federal Open Market Committee (FOMC) has held the key federal funds rate unchanged at 5.25 per cent for 13 months.
“I suspect Mr Bernanke would like to avoid that as it sends the message that the FOMC, as recently as Tuesday, was underestimating the problem,” said Mr Joel Naroff of Naroff Economic Advisors.
Some analysts say the Fed can only blame itself for the quagmire. By slashing interest rates to 1 per cent in 2003 to fight deflation, the central bank flooded the market with cheap money, which led to excessive risk-taking. And by riding to the rescue in times of distress, as it did when the dot-com bubble burst about seven years ago, the Fed has encouraged bad habits among investors.
“In effect, the central bank is promising at least a partial bailout of bad investments,” Mr Gerald O’Driscoll, a former vice-president of the Federal Reserve Bank of Dallas, wrote in a commentary in the
Wall Street Journal on Friday.
“If investors come to expect that the policy will persist, then they will deliberately take on additional risk without demanding commensurately higher returns,” he wrote.
Investors now expect the Fed to make an urgent rate cut — before its next planned FOMC meeting in September. “The Fed will probably wait a few more days to see if things come under control, but they may not be able to wait that long,” said Mr Naroff. — AFP
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