ECB President Jean-Claude Trichet
During the credit crisis the central bankers of the world bonded together in an effort to present a united front in the battle against a problem that very easily could have caused the global banking sector to crumble. However, with most of the world now well on the way to recovery, it appears that the paths of the U.S. Fed and the ECB are diverging greatly.
On Wednesday, Ben Bernanke tried to make a statement with the FOMC decision. Our view of what the FOMC said was as follows: There is not going to be a deflationary spiral on our watch. As a renowned scholar on the causes of the Great Depression, the Fed Chairman appears determined to do whatever it takes in order to stave off the potential for a repeat of the mistakes made by Japan over the past 20 years.
On that score, it is our humble opinion that Bernanke & Co. are planning to err on the side of caution for a while. How else does one explain the committee’s citing of too little inflation as a means to provide additional stimulus? Too little inflation, really?
Don’t take that wrong as we are all for the QE II and more stimulus (the more the merrier, right!). However, the justification for additional bond buying during a period of economic expansion might be a bit of a reach at this stage of the game. And before you start sending the hate mail about the need to “do something” to help unemployment, I agree that this step will likely help – in the long run. It’s just that based on my 30+ years of Fed watching, this move is clearly a little out of the ordinary.
The folks across the pond seem to agree. As opposed to the monetary love-in offered up by the FOMC on Wednesday, ECB President Jean-Claude Trichet talked tough after declining to either lower rates or do some additional quantitative easing of their own.
Despite the fact that the spreads on Credit Default Swaps hit a record high in Ireland and came quite close in Portugal on Wednesday, Trichet told a news conference Thursday that the current proposals for austerity don’t go far enough. Thus, instead of flooding the system with money the way his American Central Bank counterparts are doing, the ECB is trying to effect a change in the way countries think and manage their finances.
Not everyone in the Eurozone agrees however. The ECB "is turning a blind eye" to Ireland, says Jacques Cailloux, economist at Royal Bank of Scotland, who suggests that there is a risk of doing too little here.
But instead of talking bailouts and more stimulus, Trichet suggested that penalties for breaking the EU treaty agreement when it comes to the debt-GDP ratio should be stiffer and automatic.
In looking at the two paths being taken by the U.S. and the ECB, it becomes clear that they are almost diametrically opposed. Although Trichet did hint that the ECB would be buying some bonds on the open market in the near term, the approach is nothing like the near $1 trillion expenditure the US FOMC is committed to spending over the next 8 months.
This is a little like the differing strategies companies employ when managing their inventory and supply of components. First, there is the “just in case” approach, which in this case, is the path Ben Bernanke seems to favor right now. Using this management strategy, companies ensure that they have plenty of supply on hand so that they can be ready for anything – a at any time – and that there is no way they will wind up short.
On the other side of the coin is the “just in time” approach, which appears to be what Trichet and the ECB favor currently. Using this strategy, a company (or a central bank in this example) plans to utilize their resources by ordering just enough parts at exactly the right time so as to not waste cash flow.
So, which strategy is better? Naturally, only time will tell. However, we will point out that unlike a manufacturing company who may lose some business if their orders are late, Ben Bernanke knows that it is exceptionally difficult to stop a deflationary spiral once it gets started. As such, we’ve got to agree with the more cautious approach that Helicopter Ben and his merry band of bankers are applying at the present time.
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Comments
So, QE is about buying jobs, right? (Well, votes really, but let's call them jobs). And this has become a competition between the major economies to keep their currencies at an advantageous rate with the USD. More Competitive Easing than Quantitative Easing! Instead of allowing asset prices to fall, QE effectively supports the "price" with a lower currency value. That's understandable as a shock absorber, but it's a poor economic strategy that will merely extend the pain. Enough. Thank goodness for the ECB.
So far Uncle Ben has kept the U.S. economy out of deep doo and it looks like he will continue to do so. With the gridlock that we will now have in government thanks to the election, the Fed will control the final outcome. Frankly, Bernanke appears to be the only person in government with a plan and who actually knows what he is doing.