Getting desperate

 

There is now, as the British say, clear blue water, between us Europeans, and the Americans. To me, it seems, that the Americans are panicking. The 75bp rate cut was a sign of panic. It was an unnecessary overreaction, as will be the likely 50bp cut that follows this week.

 

The $150bn fiscal stimulus is also excessively, and wrongly targeted. And for the state to take a leading role in raising the capital base of the financial sector, as Larry Summers effectively suggested in his FT column this morning, is in my view the ultimate form of panic. They take him seriously over there, so I would expect it to happen. And while panic is rarely the right response to a crisis, it can be frightful effective if the entire system is panicking in the same direction.

 

The US is now determined to repeat all the mistakes that caused the boom: An excessive fiscal and monetary response, followed by a lack of countervailing policy action when the economy turns up. There will be another unsustainable boom at the end of the tunnel, at which time some arrogant central bankers will explain to us once why central banks should ignore asset price bubbles. This is as bad as economic policy gets. We can be glad in Europe not to have such a lousy system of economic governance over here.

 

When I read Larry Summers, it is clear to me that the Americans will do absolutely anything to avoid a recession. If it has to be a zero interest rate, it will be a zero interest rate. Now, this is not an economy with stable 1% inflation. US inflation is running at a rate of 4%. 10 year treasury bonds are at 3.5%, 30-year bonds at 4.2%. But how can this be? On the one hand, the US obviously does everything to avoid a depression, while on the other hand, the 10 year bonds markets expects a Japanese-style depression decade ahead. Both cannot be right at the same time. I suspect that Larry Summers and the US academic elites will prevail. Monetary policy and fiscal policy will go gaga, the government will actively bail out banks and insurance companies, and all this will be followed by an inflationary credit boom.

 

This suggests to us that the next financial crash is pre-programmed. Remember the great bond market massacre in 1994, when Treasury rates went up from 6.2% to 7.75% within a few months? We could easily see a repeat of that. 10-year treasuries could easily go up from 3.5% to 5%, or why not to 7.75%. Our environment is not so fundamentally different from the one in 1994.

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