By Jason Simpkins
Central banks around the world yesterday (Wednesday) announced a coordinated reduction of their respective interest rates in a bid to restore investor confidence and put an end to the worst market rout since the Depression era. However, analysts and investors alike are skeptical that even the largest coordinated effort by central banks since Sept. 11 will be enough to save the economy from a severe recession.
The U.S. Federal Reserve, European Central Bank (ECB), Bank of England, and the central banks of Canada, Sweden, Switzerland, and the United Arab Emirates each cut their key lending rate by 0.5 percentage points. The People's Bank of China lowered its one-year lending rate by 0.27 percentage point to 6.93%. The Bank of Japan did not participate in the effort, but said it fully supported the action.
The Fed's benchmark rate now stands at 1.5% and its discount rate, which was lowered by half a point, is now 1.75%. The ECB's main rate, which was raised by a quarter point in July, is now 3.75%.
"The recent intensification of the financial crisis has augmented the downside risks to growth and thus has diminished further the upside risks to price stability," the central banks said in a joint statement. "Some easing of global monetary conditions is therefore warranted."
The credit-crisis that first began more than a year ago has hit full stride, putting a freeze on lending and driving a number of large financial institutions to ruin. The London Interbank Offered Rate (LIBOR), released before the emergency rate cuts were announced, surged a 144 basis points to 5.38% more than double the Fed's funds rate – an indication that banks are wary of opening themselves up any further to bad assets and reluctant to lend to one another.
The $700 banking bailout passed last week so far has failed to assuage market fears and additional liquidity measures by the Fed have proved equally fruitless. After a number of cash injections, the Fed Monday said it would begin paying interest on bank deposits for the first time and double its planned auctions of cash to banks to $900 billion dollars.
The Fed followed that action Tuesday, by announcing plans to create a special fund to purchase three-month commercial paper from banks and non-financial companies.
However, those measures failed to assuage the markets, and with the both the Dow Jones Industrial Average and Standard & Poor's 500 Index suffering immensely, rate cuts were the only ammunition Federal Reserve Chairman Ben S. Bernanke had left.
"We are now looking at the first page of the global- depression playbook," Carl Weinberg, chief economist at High Frequency Economics, told Bloomberg News. "The only solution is to cut rates as close to zero as you dare," pump money into the banking system "hand over fist" and increase government spending, Weinberg said.
The Dow had its biggest point loss ever Sept. 29, when it shed 777 points after Congress first rejected the bailout bill. The benchmark index is down more than 30% year-to-date. Meanwhile, the S&P 500 is suffering through its worst year ever, now that it has lost 33% of its value in 2008.
Bernanke's Last Rabbit
Indeed, this massive coordinated rate cut may be the final rabbit Chairman Bernanke has to pull from his proverbial hat. And, yet, there are significant signs that the U.S. economy, as well as the global economy, is set for a severe recession.
U.S. economic growth slowed to just 2.8% in the second quarter, down from the 3.3% originally reported. And even that modest growth was the result of a small consumer spending bubble artificially inflated by government stimulus checks and a surge in exports, which was directly attributable to a weak dollar.
Consumer spending plateaued in August after a slight drop in July, and while the Commerce Department has yet to release its September figures, there is already evidence of a substantial drop-off.
Discover Financial Services (DFS), which surveys 15,000 adults each month about their spending habits and impressions of the economy, said yesterday that its consumer spending index fell 2.2 points from September to August. , according to Forbes.
Wal-Mart Stores Inc. (WMT) a retail sales bellwether that typically thrives in times of economic turbulence has already reported a slightly lower-than-expected 2.4% rise in sales at U.S. stores that had been open at least a year during the month of September. Mid-price retailer J.C. Penney (JCP) posted a 12.4% drop in September sales.
Any hope that the holiday season would rejuvenate American consumers was dashed by the National Retail Federation, which forecasts a scant 2.2% increase in end-of-year retail purchases – the slowest rate of growth in six years.
Meanwhile, the broader job market continues to shed jobs,. General unemployment held steady at 6.1% in September, but surged 0.4% in August and is up 1.4% from a year ago.
Exports, which contributed 2.9 percentage points to second-quarter growth, won't be much of a help going forward, either, as orders from overseas markets are beginning to falter. The Institute of Supply Management's export gauge fell from 57 in August to 52 in September, and worse, the group's factory index slumped to 43.5, its lowest level since October 2001, from 49.9 in August. All these figures are indicative of a severe drop in manufacturing.
With so much negative data, it's hard to imagine a half point rate cut will do much to spare the economy from a recession, or worse, depression.
"In normal times, a rate cut would have a positive effect," Gary Schlossberg, senior economist at Wells Capital Management told Bloomberg. "What's troubling the market" is concern about "the solvency and losses of major institutions. The market is uneasy because it doesn't have a lot of information on what the depth of those losses will be."
The International Monetary Fund earlier this week said the global economy is heading for a recession in 2009 and increased its estimate of losses from the financial crisis to $1.4 trillion.
[Editor's Note: With so much uncertainty permeating the U.S. economy it's a good time take the advice of a long-time friend of Money Morning, and acclaimed investment analyst, Peter D. Schiff. Schiff is a best-selling author and analyst for CNBC. He predicted our financial crisis long before it was ever on the radar, and you can receive a free copy of his book by clicking here: "Crash Proof: How to Profit from the Coming Economic Collapse."]
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