Friday, February 8, 2008

Central banks have 'lost control' as markets continue turmoil

Soros and others criticize Fed decision to slash rates

Alia McMullen, Financial Post
Published: Wednesday, January 23, 2008

Brendan McDermid/Reuters
Wild swings swept through global stock markets for the third straight day Wednesday as world business leaders called for new financial-sector regulation because the central banks had "lost control."

Financier George Soros, at the World Economic Forum which opened in Davos, Switzerland, Wednesday, said central banks had lost their nerve and new leadership is needed to fix the global economic crisis.

"We need a new sheriff, not the Washington consensus," said the billionaire speculator and chairman of Soros Fund Management.

"I think we do have to rescue markets, otherwise we would go into a depression like we did in the 1930s."

Lawrence Summers, a former U.S. treasury secretary, agreed. "There does need to be somebody and some authority doing what hasn't been done as this crisis has gathered for six months," he said at the meeting.

The criticism comes amid further turbulence in global stock markets, which caused Ben Bernanke, chairman of the U.S. Federal Reserve, to slash U.S. interest rates by 75 basis points to 3.50% in an emergency effort to quell the markets on Tuesday.

The cut gave markets a temporary reprieve, but for many, it was too late in coming.

"What the Fed's easing will do hopefully is put a floor under the downturn, but they ominously set the stage for another bubble-led economic recovery," Stephen Roach, head of investment bank Morgan Stanley in Asia and noted bear, told Reuters in a television interview.

He said it was a concern that the Fed had been forced into action by the markets, and that such an approach would ultimately end in tears.

"They're going back to the same old story that we've had to put up with for the last seven years, and that's excessive monetary accommodation that takes us from bubble to bubble to bubble," he said of the strategy to uphold the markets.

"It's time to put an end to this, I think, very reckless way of running U.S. monetary policy."

The market has certainly been moving in reckless swings this week. The negative sentiment plagued stocks in early trade yesterday. But reports that New York State insurance regulators had met with U.S. banks to pressure them into providing up to US$15-billion in fresh funds to support struggling bond insurers drove financial stocks higher and lifted the market near the close.

The S&P 500 closed higher for the first time in six days, rising 28.10 points, or 2.1%, to 1,338.60. The Dow Jones industrial average gained 298.98 points, or 2.5%, to 12,270.17, while the Nasdaq climbed 24.14 points, or 1.1%, to 2,316.41. In Canada, the S&P/TSX composite index closed up 16.52 points, or 0.1%, at 12,657.40.

Meanwhile, Mr. Roach said the Fed had used up a large chunk of its ability to influence the economy through rate cuts and risked running out of ammunition.

BMO Capital Markets economic analyst Robert Kavcic said the Fed's responsibilities were not to appease the markets, but to look after inflation and economic growth.

"But there comes a point when asset markets or housing markets start to have an impact on economic growth," he said, adding that the Fed cut largely for macro reasons.

Mr. Kavcic said the Fed would likely cut interest rates again next week, with rates dipping to 2% by the third quarter of 2008.

Meanwhile, the markets did not take kindly to comments from European Central Bank president Jean-Claude Trichet yesterday that inflation remained the bank's main concern, suggesting the bank would not cut rates in response to market volatility.

"`Particularly in demanding times of significant market correction and turbulences, it is the responsibility of the central bank to solidly anchor inflation expectations to avoid additional volatility,'' Mr. Trichet said in front of the European Parliament in Brussels.

The comments were seen as a big reason for the initial dive on North American stock markets.

Financial Post

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