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Central banks unleash the Nuclear OptionGary Dorsch Desperate times call for desperate measures. As the global "credit crunch" has grown increasingly severe, central bankers are examining the Great Depression of the 1930's for possible parallels that are relevant to today's situation. Most worrisome, is the synchronized meltdown of the global stock markets, which had wiped-out $32-trillion of wealth, on top of another $10-trillion in losses in real estate. Many of world's largest banks have become "zombie banks," and are no longer able to survive on their own without artificial life support from the federal government and the taxpayers. Banks are holding hundreds of billions of dollars of toxic assets in their vaults, with no idea how much they are worth, and this uncertainty has stopped banks from lending to businesses and individuals, resulting in the most severe credit crunch since the 1930's Great Depression. Lessons from the bursting of the Nikkei-225 bubble in the early 1990's, and Japan's "decade of lost growth," focuses on the need to avoid deflation and intensifying deflation expectations. With the threat of a deflationary spiral and double-digit unemployment looming on the horizon, central banks throughout the world are now engaged in a race to the bottom on interest rates. Furthermore, central banks are turning to the weapon of last resort, the so-called Nuclear Option, - or "Quantitative Easing," (QE) in order to keep credit flowing to the private sector. Central banks are pegging overnight interest rates near zero-percent, and pumping huge amounts of cash into the money markets, by buying commercial paper, corporate and government bonds, alongside mortgages. If done on a massive scale, QE is as a powerful stimulus, and ultimately can stabilize an economy, and buy time for the financial system to recover. Among the Group of Seven industrial nations, the European Central Bank is the most hawkish, targeting its overnight loan rate, at a paltry 1.50%, but its reluctant to cross the Rubicon, by pegging interest rates near zero-percent, and purchasing huge blocks of government bonds, in order to force long-term interest rates lower. In a flash of déjà vu, Japan's Nikkei-225 index fell to the 7,000-level this month, its lowest since 1982, after the Dow Jones Industrials briefly slumped to a 12-year low. Tokyo's financial warlords, the world's most brazen interventionists, are threatening to set-up a government body that will buy as much as $200-billion of exchange-traded funds and shares directly on the Tokyo stock market, to artificially prop-up prices, Finance chief Kaoru Yosano warned on Feb 24th. Bank of England Experiments with QE A prolonged climate of deflation is a central banker's worst nightmare, - it tends to deter consumers from spending until prices become even cheaper, and there is a risk that deflation could become so deeply embedded in consumer psychology, that it can lead to a prolonged period of falling prices and chronically weak company profits. Deflation, or falling prices over a long period of time, increases the cost of servicing debt as cash inflows are squeezed. Matters are made worse by falling wages and job losses, which can led to widespread defaults on auto and credit card loans. Although the UK-economy has been spared the trials of deflation since 1947, the Bank of England is worried that British households with high debts could fall prey to the "debt-deflation" trap this year. Britain is a nation of borrowers rather than savers, and it was a combination of falling prices and soaring debt burdens that plagued the US-economy in the 1930's. Britons' total personal debt - the amount owed on mortgages, loans and credit cards, stands at £1.46-trillion, up 165% since 1997, and each household now owes an average of about £60,000.
Thus, the BoE's monetary policy going forward is expected to be geared towards combating the scourge of deflation. Alongside a half-point rate-cut to 0.50% on March 5th, the BoE unveiled its nuclear weaponry, aiming to purchase £100-billion of British gilts, and £50-billion earmarked to buy corporate bonds and commercial paper. Some £75-billion will be disbursed over the next three-months. BoE chief Mervyn King commented, "Nothing in life is ever certain. These measures, we think, will work in the long run. I can't be sure how long it will take." "We are now towards the end of what is pretty clearly going to be a first quarter in which national output falls very sharply," said BoE member Kate Barker on March 13th, "I strongly support the move to quantitative easing, and once it became necessary, it was important to act in a decisive manner. To gauge the effect of the purchases, I will be looking for a flatter gilt yield curve, narrower corporate bond spreads, and other positive effects on a range of assets. The bank may need to reverse these gilt purchases quickly, once they have their effect," she said. The BoE's shift to QE jolted the British gilt market, driving benchmark 10-year yields below the December lows of 3%, and into closer alignment with the slumping Dow Jones Commodity Index, which is hovering -30% lower than a year ago, measured in local currency terms. Although the UK-government's official inflation rate is elevated in positive territory, it's widely expected to turn negative in the months ahead, mirroring the sharp slide in the global commodities markets.
The lessons learned from the Great Depression, and Japan's post-bubble economy in the 1990's, has moved several central bankers into shocking the system with QE, trying to arrest deflationary expectations and reduce the real burden of debt. The Bank of England has moved boldly, aiming to resurrect the devil of inflation. Whereas the Japanese spent around 5% of their GDP on QE, or printing money to buy JGB's, the BoE on the other hand, has committed to spending just over 10% of GDP. This comes at a time when the UK's M-4 money supply is already expanding at a record +18.8% annualized clip, and could soon rival the growth rates seen in third world countries. But with a record 2-million Britons signing on for unemployment benefit last month, the BoE has no interest in defending the principles of sound money. "Most of us come from the generation that grew up believing that mass unemployment and world recession were things of the past, relevant to the history books but not the textbooks," declared BoE chief Mervyn King on March 17th. "That assumption is under threat," he warned. To read the rest of this article, click on the link below: http://www.sirchartsalot.com/article.php?id=106 Mar 19, 2009 321gold Ltd |
