Central banks of the world’s two largest economies, the U.S. and China, have sought to reassure investors their respective economies are robust enough to forgo hand-holding.
In a delicious irony, it is their own words of encouragement that have prompted mass-scale selling in stocks, bonds, and commodities. As a result, the global economic slowdown we’re suffering through is about to get worse. And that can only mean one thing: More trillion-dollar stimulus programs from the U.S. to Europe to Asia.
The Federal Reserve’s Ben Bernanke, for the second month in a row last week, tried to convince investors that policymakers would only taper their $3 trillion-plus bond-buying program if economic growth were sustainable, saying the time frame could be this year or next. It didn’t work, and panicked investors sold just about everything in sight.
The decline in investment markets will surely deliver a one-two punch. China is already in a bear market for stocks as manufacturing shrinks and borrowing costs soar. Germany’s finance minister said Monday that euro-zone unemployment is “horrible” and poses a “security issue” for member countries. And here at home, Federal Reserve Bank of St. Louis President James Bullard said Friday that withdrawing the stimulus is inconsistent with slow economic growth and low inflation.
|Investors hold their breath waiting for the Fed and ECB to act.|
As investor and consumer sentiment inevitably sinks, Fed and European Central Bank policymakers will have to step up to the plate one more time to hold the fragile economic markets together and restore a state of stable disequilibrium.
So the big question is: “When will the Fed and ECB act?”
Note that there’s no “if” in this question — it’s only a matter of time.
While we wait for the world’s central bankers to respond, I thought I’d share with you the following anecdote that describes the fundamental plan that the Fed and ECB have in place to solve the world’s economic problems in a simple, yet powerful, way …
Imagine a small town on the southern coast of France where the summer holiday season is in full swing. But like in the rest of Europe, there is not much business happening.
Everyone is heavily in debt.
Luckily, a banker from the ECB arrives in the foyer of the local hotel. He asks for a room and puts a 500-euro note on the reception counter, takes a key and goes upstairs to inspect the room.
The hotel owner takes the banknote and rushes to his meat supplier to whom he owes 500 euros.
The butcher takes the money and races to his supplier to pay his 500-euro debt.
The wholesaler rushes to the farmer to pay 500 euros for the pigs he purchased some time ago.
The farmer triumphantly gives the 500-euro note to a local business owner who gave him services on credit.
The business owner goes quickly to the hotel as he owes the hotelier 500 euros for the conference room he used to meet with customers.
At that moment, the banker returns to the reception desk and informs the hotel owner that his room is unsatisfactory. So he takes back his 500 euros and leaves.
There was no profit or income, but everyone in the town no longer has any debt, and the townspeople can look optimistically to their future. It’s a brilliant solution.
That imaginary story demonstrates how the creation of new money, combined with the power of monetary velocity — that is, the speed at which money moves through the economic system — could work together to solve the financial crisis.
However, the relationship between the world’s debtors and creditors are far too complex for a fairytale ending, but central bankers can at least push off the pain to another day.
Indeed, their monetary policies do provide hope. And it’s hope, combined with more easy money from the Fed and ECB, that will stabilize financial markets one more time.