Economy For Sale
Written by A Forex View From Afar on Thursday, September 11, 2008“Car For Sale. No brakes, no engine, lots of careful owners. Going cheap, all offers considered”.
Would you buy it? The central bankers are dealing with the economic equivalent of the above advertisement. "Economy For Sale....."
Monetary policy needs a transmission mechanism in order for it to be successfully implemented, and central banks know that the required mechanism is in the form of financial stability. Without it, a central bank can cut (read Fed) or raise (ECB) as much as it wants, because without an engine nor brakes the lever will not reach the real economy. The Fed can push as much as it wants the gas pedal and the ECB the brake pedal, but neither is going to get too far.
The Fed was born from the need for financial stability, bank crisis were all the rage at the beginning of the 20th century, and in that environment the Fed had spawned, and although managing to make the crisis cycles less frequent, they are now much more powerful.
In a simple form, financial stability can be described as the position in which the financial system can absorb shocks, avoiding any affects over the real economy. There would be no real point in arguing how strongly the credit crunch affected the real economy, not too many remain unaffected by it. The problem raised now is when financial stability can actually be achieved. Banks have taken massive losses on their balance sheets; sources say financial entities have written down a little over $500 billion since the sub-prime began. Adding to this, bank capitalization has fallen dramatically in the last period (the XLF had almost fell 50% in the year).
The LIBOR (London Inter-bank Offered Rate) shows that inter-bank “health” is rock bottom, while the default swaps market for financials’ debt is all but over.. In such a backdrop the financial sector may need a (much) longer period to stabilize than previously estimated, and thus the central banks may see their monetary policy inefficient over the short to medium term. The affect on this will likely be to empower the dollar more than other regions, only because it looks as though the Fed where the most pre-emptive of the major banks.
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