The Hindu Business Line : Central banks succeed in easing liquidity

For the US economy, 2008 has begun on the wrong note. It began with a sub-50 reading on the ISM manufacturing index (which measures confidence, outlook, order books, employment and price pressures in the factory sector), suggesting weak business conditions ahead. In fact, figures below 50 are indicative of recession and have not been seen for quite some time now.

Adding more fuel to the fire was the bellwether employment data — payrolls, which report new jobs created in non-farm sectors. December added only 18,000. The unemployment rate rose tens of basis points to 5 per cent from 4.7 per cent.

The housing, sub-prime mortgage and credit crises are obviously taking their toll. Is it the beginning of a significant downturn that could push the US economy into a recession, deeper and longer than any seen in recent times? The stretched and stressed budget and debt levels of personal finances as a result of the collapse of house prices and soaring energy and food prices paint a picture of distress — not at all good news for an economy dependant on the consumer for two-thirds of GDP.

Not that banks are in great shape. Write-offs and provisioning for failed and delinquent assets are already into tens of billions of dollars. There is no knowing what the final bill will be or when it will arrive. Meanwhile, even loans not in delayed payments or default are unable to be financed, prompting the US treasury to promote a multi-bank initiative to fund such assets.

Clearly, the risk is ‘credit aversion’ — banks becoming unwilling to lend.

Collective action

The Fed, ECB and the Bank of England are stoically and heroically addressing the liquidity issue. They have collectively pumped in hundreds of billions of dollars into money markets in a gigantic effort to restore confidence and reduce inter-bank interest rates, which have strayed far above the central banks’ benchmark rates. They have succeeded in shrinking the risk premium on ‘AAA’ short-term lending to around 1.5 per cent from over 2 per cent at the height of the turmoil.

Reassuring picture

The picture on strengthening the post write-offs and provisioning capital base of banks is reassuring with the Arabs, China and the new avatar of ‘sovereign wealth funds’ enthusiastic about investing in stricken banks — Citibank, UBS, Merrill Lynch, Morgan Stanley and the like. The coming years will see the gradual passing of ownership (and control?) to non-Western investors and institutions.

The Fed must taste the bitter medicine (for a central bank) of further rate cuts. Its twin objectives of price stability consistent with full employment would seem to leave little choice.

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