Britannia Radio

This starts off by examining the dire state of the US economy but 
then turns (and this is where it becomes 'chilling')  to the general 
argument that the British economy  needs bank rate cuts.  This policy 
is almost received opinion in Britain today but Halligan challenges it.

I'll be glad to see the reaction of other economists to what seems 
like a heretical position .
xxxxxxxxxxx cs

SUNDAY TELEGRAPH   2.11.08
US RATE CUTS SEND OUT A CHILLING WARNING WE CAN'T AFFORD TO IGNORE

Ben Bernanke will make things a lot worse by repeating Alan 
Greenspan's mistakes

It may have slipped your mind, but this week the United States 
chooses a new president.

By Liam Halligan

The selection of the world's most powerful politician is, by any 
standards, a hugely significant event. For the first time, someone 
who isn't white could soon be running the White House - making 
Tuesday's vote even more historic.

Yet few of us seem to be watching, not in Europe anyway. So concerned 
are we about the credit crunch, and the impact it will have on our 
jobs, shares and mortgages, that political history is passing us by.

The airwaves are full of breathless updates from America's campaign 
trail, with reporters almost imploring us to take an interest. But we 
find it difficult to focus on Pennsylvania, Florida and Ohio. The 
real story is that the 44th President of the United States will 
inherit an economy more grim and fraught with challenges than any 
since Franklin D Roosevelt took office in 1933. And we know that's 
bad news for us.

The shape of global commerce is changing. At some point over the next 
20 to 30 years, America will cease to be top dog. But, for now, the 
US remains easily the world's biggest economy. And here in Britain, 
we're particularly exposed, with the US accounting for almost a fifth 
of our trade, not to mention the corporate and cultural ties that 
bind our economic fate.

Last week the Federal Reserve cut US interest rates by another 50 
basis points. In little more than a year, they have fallen from 
5.25pc to 1pc. Now, more than at any time since FDR was in power, we 
need that rate cut to boost America's economic prospects. But the 
Fed's latest move will harm the US and, in turn, the rest of the world.

New data shows American GDP contracted 0.3pc between July and 
September. It could have been worse. Total output shrank $2bn in the 
third quarter - in an economy that turns over $11,700bn a year.

But let us be in no doubt, the US is heading south fast. Third-
quarter consumption plunged 3.1pc. This represents the biggest fall 
since 1980. And that predates October, which was the bleakest month 
of the credit crunch so far.

If consumer confidence is collapsing, corporate earnings already 
have. With the third-quarter reporting season in full swing, the 
numbers are truly dire. Back in July, amidst hope the crunch had been 
broken, industry surveys predicted 12pc earnings growth during the 
third quarter.

But with many of America's top listed companies having reported, the 
grim reality is that third-quarter earnings are down a staggering 
24pc on last year. Since mid 2007, US company profits have now 
suffered to a similar extent as in 2001/02, when the 9/11 atrocities 
combined with the dot-com collapse. But, of course, this time there's 
worse still to come.

I take my life into my hands as I venture this - but are US base 
rates of 1pc really the answer? I would argue emphatically not.

Rates hit 1pc after 2001/02, when then Fed chairman Alan Greenspan 
swung his monetary chainsaw willy-nilly. And that unleashed the 
biggest credit bubble the world has ever seen. I thought we all 
understood that.

  However, now Ben Bernanke risks repeating his predecessor's mistake.
In the US and across the world banks aren't lending to each other due 
to fears about the hidden sub-prime toxic waste that lurks on each 
other's balance sheets. Cutting base rates does nothing to curb that 
problem.

In fact, by giving US banking executives hope that the economy may 
recover before they have to write down the full extent of the losses 
they have buried, the Fed only further delays what is so badly needed 
- a thorough purging and consolidation of America's banking system. 
And as central banks elsewhere follow the Fed and slash rates, this 
debilitating torpor is exported.

Like so many Western economies, the US needs to save more and borrow 
less.

Rate cuts undermine both objectives. With inflation standing at 
4.9pc, American savers have long received negative real returns - and 
now the Fed has just made such returns even worse, widening the 
already gaping mismatch between the supply and demand for funds.  
[Savers here are already in 'negative territory' -cs]

While US firms and consumers face high credit costs, the price of 
money on the interbank markets, and therefore the broader economy, 
has become completely detached from base rates, despite months of Fed 
cuts.
Dollar Libor has eased only very slightly in recent weeks as the 
banks have started lending out the government's bail-out money. We 
will see if the interbank rate keeps falling when the banks return to 
lending their own cash, once the bail-out pot runs dry.

Almost every economist I know backs the Fed's latest emergency rate 
cut. Even if they accept the arguments which I have laid out above, 
they claim that Fed chairman Mr Bernanke has stopped America's 
situation from getting worse.

Really? The US still has a big inflationary problem. And now we have 
both a monetary and fiscal policy that is wildly expansionary. That 
could easily spark more inflation, despite the economic slowdown, 
undermine real income and prolong America's slump.

Having lowered rates to 1pc and having vowed to avoid a zero interest 
rate policy, the Fed now also has almost no more ammunition. While 
the markets clamor for cuts, rates this low send out a chilling signal.

How much sub-prime is out there? Just what does the Fed really know?

This week, the Bank of England is likely to follow the Fed's example, 
so intense is the pressure to do something. But, just as in the US, 
deep cuts in Britain will not address the real issue and could well 
make matters worse.