Bernanke - $700 billion injection of new money into the economy is not an inflation threat

Foreign Exchange Outlook : Bloomberg reports that Fed funds futures are pricing in an 80% chance the Fed will cut rates at the October FOMC, up from 58% only on Tuesday and 23% last week. Meanwhile, both the Bank of England (in the form of policy member Sentence) and the European Central Bank (various officials) continue to concentrate on taming inflation, chiefly in the form of keeping it creeping into wages. This dichotomy is disturbing, especially since Bernanke said yesterday that the $700 billion injection of new money into the economy is not an inflation threat (without also explaining how it will be sterilized).

Today the FT has a report on comments by German FinMin Steinbrueck, who told the German Parliament that the US will lose its status as the superpower of the world financial system. This world will become “multipolar” as stronger, better-capitalized financial centers emerge in Asia and Europe. “The world will never be the same again.” The FT calls it a “biting attack” on the US for having resisted urgent pleas for better regulation starting last year.

Crisis management alone will not rebuild the lost confidence. We must civilise financial markets, and not just through moral appeals against excess and speculation. Self-regulation is no longer sufficient.

The FT writes that he said The US belief in “laisser-faire capitalism; the notion that markets should be as free as possible from regulation; these arguments were wrong and dangerous,” he said. “This largely under-regulated system is collapsing today.” He pointed the finger at Washington for failing to take seriously proposals Berlin had made as it chaired the Group of Eight industrial nations last year. These proposals, he said, “elicited mockery at best or were seen as a typical example of Germans’ know-better attitude.”

“Unlike the US two-tier banking system, he said, Germany’s three-pillar system had weathered the storm. The network of savings banks, much derided in the past by US critics, had provided business with more credit in the first half of this year than in the same period last year.

“Mr Steinbrück put forward eight proposals to help resolve the current crisis and prevent future financial meltdowns on a similar scale. Among these were a ban on “purely speculative short-selling”; a crackdown on variable pay for bank managers, which had encouraged reckless risk-taking; a ban on banks scrutinising [sic] more than 80 per cent of the debt they hold; international standards making bank managers personally responsible for the consequences of their trades; and increased co-operation between European supervisors, culminating in the long term in a European supervisory system.”

Steinbrueck is an important guy and he has one giant germ of truth in here - that the absence of savings in the US made the banking system vulnerable to raising funds by inventing new classes of debt. It’s not really true that the German banking system is better than the US system structurally except for this aspect—but banks don’t get credit for it. Social norms and tax policy get credit for it.

German banking is notoriously inefficient.

Banks fail left and right.

The state-owned banks get special treatment, much like Freddie and Fannie used to get.

And Steinbrueck is wrong that the world is throwing the US away as the leader in favor of other centers in Europe and Asia.

Financial institutions in Europe and Asia have not disclosed their problem assets to the same degree as the US.

There is a lot of rotten paper in London and Frankfurt, hiding under the rug. And the preeminence of the US system is due in part to the size of the US economy but also to the rule of law (hello, India?), the primacy of individual property rights (yes, China?), and the freedom of markets from undue regulation. What? Yes. Even when the US is in full regulaotry mode, we have less red tape and regulatory burdens than in Europe and certainly less than in Japan. We also have a higher degree of greed, which inspires financial market innovation, not all of which is evil and unethical (the concept of CD’s, commercial paper, ATM’s, credit and debit cards, linked accounts, etc.—all invented here, not in Germany).

The US has much to be ashamed about now. In the 1930’s the chairman of the New York Stock Exchange (Whitney) was indicted and went to jail for stealing frm his customers’ brokerage accounts.

In other words, it was ever thus - the financial system running off the rails. But stupidity and cupidity are not solely American traits - think Herstatt. Think Barings. Think Mitsubishi.

In sum, we will get over this whatever the Congress and Treasury Secretary do and whether the recession is long or short. Three hundred million people are not going to go live in a cave and use barter to get food. The system is not broken beyond repair—it just has a big hole in it. Banking, with any luck, will become boring again as the hotshots and math whizzes go wreak havoc in some other field.

But to say the US will come out of this one day is not to help with the imemdiate US dollar forecast. While we have to expect a relief rally at some point, and perhaps very soon as Congress does the deed, the longer term outlook for the US dollar exchange rate is grim. And we still want to hear how Bernanke is going to sterilize $700 billion.

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Barbara Rockefeller - Forex Trading Reports

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