Central banks, in a cold sweat panic, cut rates and their own throats

Clap and the banks will lend!

So, central banks around the world, including the Chinese, amazingly, all cut rates by .5%. The reason, as one trader friend said to me "I was watching the FTSE open, and it just fell off a cliff." Which is to say, overnight foreign markets tanked.

The result of the rate cuts? Well at the end of the day, the DOW was down 189.01. Better than falling off a cliff, but not exactly a recovery, was it? This puts the Fed funds rate at 1.5%. Given that 3 month annualized core inflation (ex energy and food) is running 3.4% and overall inflation is running at 7.2%, this means the Fed isn’t just giving money away, it’s effectively paying banks to take it, and that’s before you get to the Fed’s announcement that it will start paying interest on reserves.

When you get to this level, and the economy is still in the doldrums, it’s a sign that monetary policy is becoming ineffective. Japan gave money away for most of a couple decades, and it didn’t do a damn thing. Banks may be able to borrow for cheap, but they don’t much want to lend right now because it’s not worth their while. Bear in mind inflation is running somewhere between 5 and 7%, to stay even with inflation they have to lend at interest rates higher than that.

Most of the problems in the credit markets are in short term credit. Usually that stuff is very cheap. The Fed wants it to stay very cheap. The banks, however, see no reason to lend to people for below the rate of inflation plus a profit, especially when default risk is seen as relatively high. To put it more simply, the rate that would certainly get banks lending in the short term markets again (other than treasuries) is somewhere between 8.5% and 10.5%. (1.5% cost of money + inflation + 2% profit). You might be able to get them to lend at no profit, no loss, with a bit of arm bending. Color that number 6.5% to 8.5%.

You can see why banks aren’t eager to lend to the short term markets. What is more likely to help the situation is inflation dying down, and there’s every reason to think it will, as the economy goes into the doldrums and oil continues to drop. Ironically, however, all this pump priming and flooding the world with money is inflationary. I suspect it won’t stop inflation from slowing anyway, but it will make that decrease in inflation less than it would have been otherwise. It is quite probable that Fed and Treasury actions over the past year have actually making the situation worse rather than better, by not allowing inflation to die, and thus not making it worth it for banks to lend.

As for priming the stock market? Doubt that’ll work either. Investors and traders are worried about fundamentals, and until they’re convinced those are fixed (and a .5% drop won’t fix squat), they aren’t going to really rally.

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4. Raising Their Rates, Health Insurance Companies Put Themselves in a Box
5. Seance on Wall Street