Thursday, June 17, 2004

What Would A Responsible Central Bank Look Like?

It might sound something like this. (Guardian (UK))

Tuesday June 15, 2004
The Guardian

Bank of England governor Mervyn King yesterday delivered a stark warning that house prices could be heading for a fall and interest rates will have to rise further to keep inflation under control.
Using unusually tough language to get his message across, Mr King said cost pressures were building, the ratio of house prices to average incomes had risen to unsustainable levels, the labour market was getting ever tighter and there was little spare capacity in the economy.

The Bank's monetary policy committee last week imposed its fourth rate rise since November. It was the first time it had increased borrowing costs two months running since early 2000. Rates are now 4.5%.

Mr King warned that the MPC was not finished yet, saying it was a question of when, not if rates would rise further. "How far interest rates will need to rise in order to keep inflation on track to meet our 2% target for CPI inflation in the medium term is impossible to say with any degree of confidence," he told a CBI dinner in Glasgow.

Economists are predicting rates will be at 5.25% by the end of the year and expect the next rise at the MPC's August meeting. Mr King's words may stoke talk of a July increase.

The Bank governor also warned homeowners who are considering moving to think very carefully about where prices and interest rates are likely to go. There were plausible reasons, such as the shortage of housing, low inflation and low interest rates, to explain why the ratio of house prices to average earnings had risen over the past 10 years.

"Nevertheless, it is now at levels which are well above what most people would regard as sustainable in the longer term.

"There are some early signs, from surveys, of a slowdown in the housing market. After the hectic pace of price rises over the past year it is clear that the chances of falls in house prices are greater than they were."

As he spoke, data from the Office of the Deputy Prime Minister showed annual house price inflation rising to 10% in April from 7.8% in March, although the new figure is well below the 20% reported last week by the Halifax.

Unfortunately we have a Central Bank in the USA that is addicted to foreign debt. It is the buying of debt by foreigners to maintain artificially low exchange rates that funds lower American interest rates. Without this bleedoff of our money supply we would already be experiencing either higher interest rates or massive inflation. The question is how long can this shell game be kept up however? (FT)

The US trade deficit widened to a record $48.3bn in April, putting a bigger drag on economic growth than expected and further damping down hopes that the trade gap is soon set to narrow.

The deficit was up from $46.6bn in March and was $5.8bn higher than in April 2003.

Economists said that with the dollar reviving in response to expectations of higher interest rates, there was little chance that the trade gap would start to close over the next 12 months.

The swelling US deficit is the most obvious manifestation of imbalances in the world economy, with the US outpacing growth in the eurozone and Japan. For the US administration the deficit has underlined the need for other economic blocs to do more to bolster demand.

The figures coincided with the release of data showing a rebound in retail sales, which rose by 1.2 per cent in May following a decline of 0.6 per cent in the previous month. Surging auto sales and high petrol prices were largely responsible for the jump.

Strong demand from US consumers looks likely to continue to demand ever greater volumes of overseas goods, economists said. David Ingram of, the consultancy, said several other factors would also push the deficit higher.

"The deficit with Asia in general and China in particular will only get larger if China's efforts to slow its economy are successful," he said. "In addition, with the restoration of business investment, the US economy is firing on all cylinders and is absorbing a great deal of resources from abroad."

The stabilisation of the dollar - which came under heavy pressure last year - is also expected to postpone any adjustment of the US trade position. The trade-weighted dollar rose by 0.75 per cent during April, but was 5.7 per cent lower compared with the same period last year.

This simply can't keep on going forever. In comparison to the other central banks Greenspan is engaging in a profligate monetary policy. However the piper will have his due. The question now is whether Greenspan can postpone the day of reckoning past the end of his tenure or if he will be brought low - or rather forced to raise interest rates to 5-7% to tame the demons of inflation. That sort of shock would render stillborn the economic recovery. Even rates in the short term of 3% might do that. However the alternative could be quite worse insofar as it would result in a fairly rapid destabilization of the currency and devaluation through a fear of our monetizing the debt. Then it would be a complete bananna republic debacle big time.


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