Tuesday, 1 January 2008
by Ambrose Evans-Pritchard from The Telegraph 10 June 2008 Fetch your tin helmets once again. The European Central Bank is opting for a monetary purge. So too is the US Federal Reserve, now ruled from Dallas. Über-hawks and Cromwellians have gained the upper hand at the great fortress banks. Whether or not they admit it, both are embarked on policies that must lead to retrenchment across the Atlantic world. The City mood turned wicked as the full import of this policy switch sank in last week. On Wall Street, the Dow's 396-point dive on high volume late Friday had an ugly feel. "There is now the distinct possibility of a simultaneous sell-off in global bonds, equities and commodities," said Jonathan Wilmot from Credit Suisse. ECB chief Jean-Claude Trichet has "signalled" a rate rise in July to combat 3.6pc inflation, much to the fury of Paris, Madrid, Rome, Lisbon and Dublin. It is a perilous path for Europe's monetary union. "I would advise Mr Trichet to be more careful in his comments," said Spain's premier Jose Luis Zapatero. The counter-attack has begun. Spain's property crash is calamitous. House prices have tumbled 15pc since September, say the developers (APCE). Over 98pc of Spanish mortgages are on floating rates, priced off three-month Euribor. This rate leapt 32 basis points to 5.24pc after Mr Trichet opened his mouth. The ECB demarche is ominous for the rest of us as well. We may be watching a replay of the Bundesbank's ill-judged rate rise in October 1987, which sent the dollar into a tailspin and triggered the Black Monday crash. Any tilt to monetary tightening is a dangerous gamble at this delicate juncture. The world is facing an almighty clash between two opposing storm systems. The West is in the full grip of a debt deflation as years of credit abuse come back to haunt it. The East - loosely speaking - is in the blow-off phase of an inflationary boom. Russia, Ukraine, Vietnam and the Gulf are out of control. China has dithered beyond the point of no return. It is they who have repeated the errors of the 1970s, not the West. The two camps face radically different problems at this point. It will take central banking skills of great subtlety to pilot these seas. Slavish adherence to "inflation-targeting" and other such totemism and pseudo-science will ruin us all. Yes, we face an oil and food price spike. Call that inflation if you want, but note that Europe's M1 money supply has contracted over the last five months. America's M1 has turned deeply negative, while M2 and MZM growth has collapsed. America is going from bad to worse. A net 861,000 people joined the dole in May, pushing the unemployment rate from 5pc to 5.5pc. US house prices have fallen 14.4pc over the past year (Case-Shiller index). Miami is off 25pc. The Mortgage Bankers Association says 8.8pc of all US house loans are in default or arrears. Negative equity has engulfed 11m households. The "AA" rated tranches of 2007 sub-prime mortgage debt are now trading at 12pc of face value (ABX index); the "BBB" grades are down to 5pc. The debacle is reaching the 2004 vintage debt. We moved a step closer to a meltdown in the US municipal bond market last week when the "monoline" insurers Ambac and MBIA lost their "AAA" rating from Standard & Poor's. Roughly $1,100bn (£559bn) of insured debt must be downgraded in lock-step. This will force pension funds to liquidate holdings. A fire sale looms. UBS says banks could face another $200bn of losses as this unfolds. Had this happened over the winter - before the Fed rescued the banking system - it might have triggered a systemic crisis. We are in Phase II, the slow grind of economic distress. Or as George Soros puts it: "The end of a 60-year period of continuing credit expansion based on the dollar as the reserve currency." Fed chairman Ben Bernanke knows that the crunch will tame inflation over time. The CPI rate lags the cycle. It rises into the first stage of recessions. Wise bankers look beyond it. But Bernanke is now compelled - against his better judgment - to declare an end to the easing cycle. An interest floor of 2pc has been fixed. Assailed by critics as an inflationist, he is a lonely soul. His closest ally - Frederic Mishkin - is leaving. Dallas governor Richard Fisher has led a hard money revolt from the hinterland warning of a "debauching of credit". After voting against the last three rate cuts, he now wants rate rises. As for Europe, growth is stalling. Retail sales fell 2.9pc in April, the steepest drop since EMU began. Manufacturing orders in Germany have fallen for five months. Car sales in Italy dropped 18pc in May. The ECB policy shift has already had a perverse effect. By sending the dollar into a fresh dive this week, it triggered a $16 surge in the price of oil over two days. Crude is now moving almost reflexively as a sort of "anti-dollar", a currency on steroids with eight times leverage. No matter that the global economy is slowing hard. Bad is good for oil in the topsy-turvy world of commodity funds. We are in uncharted waters. The easy trade-off between growth and inflation that so flattered asset prices for a quarter century is over. The monetary lords can no longer shield us from the full consequences of our debts. Nor do they want to.