Friday, March 7, 2008

The Euro, Credit, Banking, Regulation, etc.

Yesterday, the European Central Bank decided to maintain its basic interest rate unchanged, and today the predictable effect--a further rise of the euro to $1.5431--promptly followed. Budget Minister Eric Woerth declared that this is too high, and, indeed, in terms of strict purchasing power parity it probably is. But two years ago, at a time when the US current account deficit was still growing by leaps and bounds, at least one prominent economist predicted that the euro would top out at $1.70 to $1.75, a figure that at the time seemed far-fetched to many. Today that figure seems perfectly realistic, if not on the low side.

It can't be an easy time to be a central banker. Real interest rates are now negative. Inflation is on the rise. Growth has stalled. The credit markets are in turmoil. Banks have recognized that the tools they use for risk management are inadequate. And the market no longer accords credibility to the very regulators who were being extolled only a year ago as the architects of "the Great Moderation" that had at last tamed the business cycle:

The credit markets are casting a big vote of no confidence in the idea that the Federal government can rescue the housing market.

As we noted before, spreads on agency securities have widened to extreme levels. This renders the Fed's rate cuts largely ineffective, at least if the intent was to give relief to the housing market via lower rates (note some believe the Fed wants to steepen the yield curve. Since banks borrow short and lend long, a big gap between short and long term rates will allow them to rebuild their battered balance sheets faster).

Meanwhile, the SocGen scandal took a new turn, with the revelation that the bank's physician sent an SMS to Kerviel before the scandal broke advising him to leave town. And the bank is taking advantage of a loophole in accounting rules to place its losses on the scandal in 2007 rather than 2008, a move that has caused widespread consternation.

1 comment:

Anonymous said...

You can imagine how these prospects for the euro/dollar relationship cause Americans who live in France some sleepless nights, especially if they live mainly on income in dollars. What if this forced us to return to the US? Well, at least our property in France is worth a small fortune in dollars now...