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Did They Really Say Those Things, No, Did They Really?

By Andy Shaw | January 23, 2010

Originally Posted 17th July 2008

Hi,

I thought you’d like to see some email correspondence I’ve been having with an economist friend of mine.

My email to him:

There’s been a couple of moments when I thought I was dreaming in the last couple of days so thought I’d write you for a reality check…

Did Bernanke really say that he doesn’t know which way to send the rates!

Did King really say that current monetary policy is not having much of an effect on inflation?

I only heard both of these comments 2nd hand, if they are right do you interpret Bernanke as someone telling the truth or just incompetent. And is this Mervyn’s way to be able to lower rates while holding onto the fact that he can still say his mandate is just inflation?

Maybe this is his lead in to change his mandate to include the economy?

His response:

Great to hear from you.  I miss our chats.  There are few people that are as interested in monetary policy.  There is no one who is as controversial as you.

Central Bankers have got a problem.  Oil and food costs are pushing inflation way above tolerable limits which means central bankers should raise interest rates to quell the flames. So when the ECB raises rates and the dollar depreciates and the price of Oil goes up (as it does when the dollar goes down) then raising interest rates might actually accelerate inflation!  How about this….raising rates dampens consumer spending but it has no consequence on fuel or food.   In my view, raising rates will do nothing, at best, or makes things much worse.  Have Bernanke give me a ring.

The real problem is the financial crisis.  People I respect anticipate another bank failure/rescue and are much more afraid of a deflationary spiral rather than the reverse.  Central Bankers and Chancellors of the Exchequer should be taking steps to avert recession and subordinate inflationary concerns for the moment.

My Reply:

Of course they should, something I have been saying since Nov, Dec last year when the Fed made their fools play. Even though by the intellectual world it was considered a fools play, yet still America is technically avoiding a near certain recession because of it.

Personally I think Oil and other commodities have gone beyond where they should be and I think we’ll see food dropping back as more farmers start to farm their land with the most profitable crops. I also think that the supply and demand equation for oil will result in a fall back as in my view there is an over supply, and I am hearing that tankers are effectively being parked as there are not enough buyers.

I think Mervyn’s comments are a lead in to managing the economy rather than the hitherto unbelievable policy of just managing inflation and I can actually see rates coming down by between 0.5 & 1% by the end of the year.

The question is – will the banks lower their rates to match (comfortable now with the fact that they are having their pound of flesh) or will they keep rates on hold and raise their criteria (which of course removes the benefit of a rate cut)?

The biggest concern I am seeing is job cuts as that really kills the economy and if they do not work on the economy soon then we are heading for a recession, but my opinion is that banks will lower rates and this will open the market back up nicely. This will also give exports a boost if the value of the pound falls, which I think like the Dollar will actually go on to be stronger later if they make the rate cuts, even though this goes against conventional thinking, but we’ll see.

I know you remember my comments towards the intelligence of Mervyn King earlier this year and we disagreed about his ability. In hindsight, I think you are right, he is ‘galactically clever’, he is far cleverer than me at being able to analyse to death all of the data. However, I saw all the way through that the fools play was the right move and even before they moved to do this I said that they (The UK & the US) needed to start regularly cutting rates, which is why the US (which was headed for near certain recession) is now keeping up the good fight and the UK (which was looking like it would avoid it) is now looking like it is about to start playing a game of, ‘well we’re not technically in a recession yet!’

Lowering rates was the right move then, even though it did not appear to be, and when I get frustrated with other people’s lack of vision on this sort of thing it is because I am not eloquent enough to be able to fully explain my understanding of it. Mervyn King is smart and that is what is holding him back. He does not take risks and sometimes (especially in today’s sort of economy) boldness of action can make things happen. This is where I question his ability.

Best Wishes

Andy

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