Has the Federal Reserve Bank, like the United States cavalry in the old cowboy movies, ridden to the rescue of the world’s investors just as they were about to be overwhelmed by the encircling forces of sub-prime crisis, credit crunch and Wall Street panic?
Or has the Fed, under its relatively new and untested chairman Ben Bernanke, over-reacted to a crisis created by the self-styled “masters of the universe” – the big investment banks of New York City – and opened the lid on a box of troubles that will come back with a vengeance later this year?
The world’s stock markets gave their answer on Wednesday with a predictable but resounding vote of approval, with indices clawing back many of the losses of the previous two days – which had spooked the Fed into its unprecedented intervention in the first place. With recession the word on everybody’s lips, including the other masters of the universe gathered in Davos for the World Economic Forum, the Federal Reserve action looked bold, decisive and conclusive.
The old truism that what is good for business is good for America must be amended: what is good for American business is good for the rest of the world. This is valid even in the early twenty-first century with the emergence of global rivals to the US economic dominance.
Certainly, by lowering the cost of wholesale borrowing on the world’s money markets, it has helped ease the immediate pressures of the global credit shortage that was playing havoc with bank’s balance sheets and cash flows. A sound financial system is the essential foundation for global economic security, and the Fed has recognised this with its rate cut.
At the other end of the scale, it will help revive faltering consumer confidence in the advanced economies of the west, which drive the export-led economies of the rest. If you are a mortgage holder in Detroit threatened with foreclosure, or a Northern Rock customer in the north east of England, you will be grateful to Bernanke for his incisive intervention. You will give similar thanks if you are a Chinese textiles producer or an Indian steelmaker.
So far, so good. But even as stockbrokers around the world began to breathe sighs of relief, there were warnings that the Fed move might be too little, too late, or, even worse, too much, too soon.
So a series of doubts began to be voiced yesterday. One immediate concern was that the Fed had been held hostage by the big investment banks, which had in effect demanded lower rates as the price for restoring order to the world markets. As conspiracy theories go, that it is a pretty good one, but shouldn’t be taken too seriously.
More serious was the historical precedent of the Japanese economy in the late 1980s, when a “bubble” in asset values burst dramatically – and stayed deflated for the next 15 years. If the Fed were to cut rates further, it could usher in a period of low returns on capital and stagnant asset values, again causing chaos to the world economy.
For the big Gulf investors, the Fed’s action is a two-edged sword – lower returns on dollar deposits will hurt, but if it helps maintain the high levels of foreign investment into the region, on balance it is probably just about worth it.
Bernanke’s dramatic intervention has stabilised the financial system, and that is good enough – for now.
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