What a Wim-p.
European Central Bank
President Wim Duisenberg cut interest rates by a quarter-point Thursday to 4.5%, only 10 days after suggesting that above-target inflation in the
prevented him from bringing down the cost of borrowing.
decision comes after months of intense pressure from economists concerned about a developing economic slowdown. The move also aligns the ECB with the
Bank of Japan
, both of which have recently loosened monetary policy.
The U.K. also cut rates Wednesday, aiding the
government, which this week called a general election for June 7. As a result, there's not a central banker of consequence resisting this ill-fated attempt to reflate the world's economy. The deleterious results of all this extra money sloshing about already can be seen: rising prices and vast capital waste as cheaper money spurs investment in subpar companies at the expense of good ones.
In a press release discussing reasons for the cut, the ECB said it now sees "somewhat lower inflationary pressure over the medium term." The bank also said money-supply growth figures, which have shown surprising strength, are currently overstated by non-European flows into money market funds.
Some aren't buying the official explanation. "Poor old Wim -- he caved," says Paul Kasriel, chief economist at
. "He was bullied into cutting rates."
Just at the end of April, Duisenberg said it would take until early next year to get European inflation down to the 2% target, from its current rate of 2.6%. This was taken to mean that he wouldn't cut rates till the ECB saw evidence that inflation was falling. A few days later, figures showed that European money supply, as measured by M3, rose by 5% year-on-year in March, well above the ECB's desired rate of 4.5%, and Duisenberg made some more hawkish-sounding comments on inflation. However, a steep drop in
German industrial output reported this week is assumed to be the main reason for the volte-face.
Panic in the Streets of London
But that drop can't have been the sole motivation. If it was, the ECB is getting about
as panicky as the Fed. While the German industrial output decline was unexpectedly large, it came after two years of strong growth, Sean Corrigan of
Capital Insight points out. What's more, in the past five years, the index has often dipped sharply, only to bounce back immediately. "Europe is a long way off from the sort of manufacturing recession you see in the U.S." says Corrigan.
Source: OECD, Detox.
With the world's three largest central banks marching in lockstep, global money supply is likely to continue soaring. In February, the
broad money index grew at 10% from the year-earlier number, compared with the 8.4% average gain for the last five years. Kasriel notes that the last time the world's big central banks were vigorously easing together was in the 1985-86 period, which was followed by the inflation surprises of 1987. "The Fed started tightening in March 1987," Kasriel notes. He adds that energy prices were falling back then, whereas they are soaring now.
The accepted wisdom in economics is that a central bank can be accommodative when growth and inflation are low. But neither of those conditions currently exists in Europe or the U.S. For instance, America's 2% GDP growth in the first quarter was much higher than anyone expected, and inflation, using Greenspan's favorite indicator, the personal consumption deflator, was also above expectations at 3.3%.
No surprise, then, that the grotesque misallocation of capital continues. Investors are still piling into overpriced equities. For example,
is up 33% in just two months even though it now trades at a steep nine times projected 2001 sales. And bond and equity markets seem happy to finance dud telcos, looking at
record-breaking $12 billion bond issue, completed Wednesday. Across the pond,
is asking investors to stump up $8.4 billion in a rights issue. Are telcos really the most productive place for all this cash?
BT and WorldCom look good compared to company like
which Detox examined earlier this week. Despite its problems, or perhaps because of them, cash-strapped ACT managed to borrow another $100 million from
J.P. Morgan Chase
earlier this year, boldly underlining the good-money-chasing-bad theory.
This sort of malinvestment of capital is coming back to haunt California. Years of underinvestment in power-generating capacity there now means businesses in the state are facing a 50% hike in their electricity rates, according to a proposal Wednesday from the state utility regulator.
Ultimately, bailing out broken economies and preventing the market from doing its work is what central banks were set up to do -- and they'll never stop doing it. Greenspan and Duisenberg are ensuring that money keeps flowing into overextended firms in the tech and telecom sectors, in turn protecting the banks and funds that financed them. No one asks whether it's correct for these knackered-out New Economy companies to be getting more cash. It's assumed that other sectors have enough as well. Maybe they do as long the central banks keep easing. But to ensure there is enough money requires the sort of powerful monetary pumping that only ends up causing inflation.
Until Thursday, Europe looked like it was going to avoid the violent boom-bust cycle that Greenspan is setting the U.S. up for. Where's the
when you need it? Perhaps the bond market will soon call order: Ten-year U.S. T-bills sold off Thursday and the equivalent German bund, which might have been expected to rally, didn't budge. Maybe bond investors want the old Wim back.
Know any companies that the market may be misvaluing? Detox would like to hear about them. Please send all feedback to
In keeping with TSC's editorial policy, Peter Eavis doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships.