It seems that the world's major central bankers are not as immune from the influences of the press as we initially thought. They are slowly becoming no different from those same politicians that they have for many years looked down at and accused of sacrificing long-term economic stability simply to appease the press. These days it somehow seems that if the press, whose knowledge of what is really going on with the economy is questionable at best, keep on accusing the central bankers of inaction, probably believing what they hear from the analysts and economists working for the major banks that desperately need a rate cut, that they will respond, irrespective of whether or not they believe in the potency of the response. I personally believe that the actions taken by the central banks of the U.S., U.K., Switzerland, Canada, as well as the European Central Bank will only damage their credibility in the long-run and will in no way achieve its stated objective, assuming of course that they themselves believed it would be effective to start with.

There is no doubt that the U.S. economy is facing serious problems, as are in fact most economies that rely on the U.S. The Federal Reserve has recognized the risks facing the U.S. economy and has taken steps to mitigate them, by slowly cutting rates and monitoring how they permeate through the economy. Of course, the investment and banking community are in a rush and were hoping that the Fed would have cut the rates down to zero percent by now, even though they don't say that publicly, so that they could borrow money for next to nothing in order to make up for the losses they are facing for the mistakes that they themselves have made. Now that the ecosystem of the U.S. sub-prime market has been illuminated it is astonishing that almost no institution recognized what seem to be extremely obvious sources of risk in the model.

Since the Fed did not cut rates by more than 25 basis points, due to concerns about the implications of high oil prices on inflation, the press, in response to the calls from those same bankers, pushed the central banks to do something in order to make it easier for banks to lend to one another and as a result help create another artificial bubble for a few more years.

It might also have had something to do with their worries about a collapse in house prices. After all, many journalists also live off the appreciated values of their homes. The Fed, which didn't really want to seem to be caving into pressures from the press and the banking community, had to find another way to cut rates without seeming to be doing so. The result was the establishment of a consortium of central banks that agreed to lend money to banks at discounted rates. The initial response from the markets was that it was great news since the credit crunch would be less severe and hopefully even eliminated. Of course, the reality is that while banks are now able to lend to each other at better rates it does not mean that those who were going to default are no longer going to do so. The structural problems still remain and the risks cannot in anyway be mitigated by cheaper credit for banks, unless the rates are cut to such an extent that they become negative in real terms.

The main problem of course with the concerted effort is that once the dust settles after the initial excitement associated with the announcement people might consider that what the central bankers are really telling them is that maybe the U.S., and perhaps a few other economies, are at a significantly greater risk of recession than the markets had thought. Consequently, given the herd mentality in the markets, if we start thinking that there will be a recession then banks would be even more cautious about lending to one another, basically nullifying the objective of the effort, and making the likelihood of a recession even greater.

The result is that the actions of the central bankers will be demonstrated to have been ineffective, assuming that as I mentioned above it does not have the opposite effect and pushes the U.S. towards a more factual recession, and their credibility in times of crises will have been tarnished in the eyes of the financial markets. And, those of us who have lived long enough to experience what a loss of credibility means for a central bank know that once they are demonstrated to be ineffective they lose their main tool for monetary policy, the currency starts going into play, and usually inflation starts going through the roof. But, of course, the press will then accuse them of bending to the same pressures that they are now exerting.

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