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US Slides Into Dangerous 1930s 'Liquidity Trap'
By Ambrose Evans-Pritchard in Davos
27/01/08 "The
Telegraph" -- - The
United States is sliding towards a dangerous 1930s-style
"liquidity trap" that cannot easily be stopped by drastic cuts
in interest rates, Nobel economist Joseph Stiglitz has warned.
"The biggest fear is that long-term bond rates won't come down
in line with short-term rates. We'll have the reverse of what
we've seen in recent years, and that is what is frightening the
markets," he told the Daily Telegraph, while trudging through
ice and snow in Davos.
"The mechanism of monetary policy is ineffective in these
circumstances. I'm not saying it won't work at all: it will help
the banking system but the credit squeeze is going to go on
because nobody trusts anybody else. The Fed is pushing on a
string," he said.
The grim comments came as markets continued to suffer wild
gyrations, reacting to every sign of contagion spreading to
Europe, Asia, and emerging markets.
Wall Street has begun to stabilize on talk of a rescue for the
embattled bond insurers, MBIA and Ambac.
The Fed's 75 basis point rate cut allows the banks to replenish
their balance sheet by borrowing at short-term rates and lending
longer term, playing the credit 'carry trade', hence the 9pc
rise in the US financials index yesterday. But confidence
remains fragile.
Professor Stiglitz, former chair of the White House Council of
Economic Advisers, said it takes far too long for monetary
policy to work its magic. This will not gain much traction in
the midst of a housing crash.
"People have been drawing home equity out of the houses at a
rate of $700bn or $800bn a year. It's been a huge boost to
consumption, but that game is now up. House prices are going to
continue falling, and lower rates won't stop that this point,"
he said.
"As a Keynesian, I'd say the biggest back for the buck in terms
of immediate stimulus would be unemployment assistance and tax
rebates for the poor. That will feed through quickly, but set
against the magnitude of the problem, even a fiscal stimulus
package of $150bn is not going to be enough," he said
"The distress is going to be very severe. Around 2m people have
lost all their savings," he did.
NASDAQ president Bob Greifeld expressed a rare note of optimism
at the World Economic Forum, predicting a swift rally as the
double effects of the monetary and fiscal boost lift spirits.
"I think the stimulus package that's been proposed by the
President, to the extent that this is passed in rapid fashion by
Congress, has the ability to forestall a recession," he said.
"At the moment, our business is doing better than it ever has
because the volumes have been incredibly high. So, it's been
very good for us," he said.
There were scattered signs of improvement across the world
today, with Germany's IFO confidence index defying expectations
with a slight rise in January. Japan's quarterly export volume
held up better than expected.
Even so, the global downturn may already have acquired an
unstoppable momentum, requiring months or even years to purge
the excesses from the bubble.
Professor Stiglitz blamed the whole US economic establishment
for failing to regulate the housing and credit markets
adequately, allowing huge imbalances to build up.
"The Federal Reserve and the Bush Administration didn't want to
hear anything about these problems. The Fed has finally got
around to closing the stable door (on subprime lending), but the
after the horse has already bolted," he said.
© Copyright of Telegraph Media Group Limited 2008
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