Monday, September 8, 2008

Does Someone Want A Worldwide Liqudity Crisis?

As I have pointed out recently, the Federal Reserve has just about stopped adding liquidity to the economy. Money supply growth over the last three months is down to 1.8% on an annualized basis. Earlier this year the Fed was pumping money out at double digit rates.

Now comes word that the Bank of England (BOE) explicitly ruled out extending its Special Liquidity Scheme (SLS), while the European Central Bank (ECB) is reportedly considering tightening its lending criteria. WTF?

Great Britain's Chancellor of the Exchequer, Alistair Darling, Britan's senior economic official said last week that Britain is facing "arguably the worst" economic downturn in 60 years which will be "more profound and long-lasting" than people had expected, according to UK's Guardian.

Cutting sources of liquidty while the economy is going into "arguably the worst" economic downturn in 60 years? Do you see something wrong with this picture?

The BOE and ECB have been provding huge suppliers of liquidity to British banks. The SLS is thought to have provided £50 billion or more, while the ECB has lent banks €467 billion.

Despite pressure from some British banks for an extension, the SLS will be closed to new applications from the week of October 20, the BOE said.

According to sound business cycle theory, central banks shouldn't be messing with the money supply at all, but when the central banks pump money in the system for decades and then pull the rug out on providing liquidity, something else is going on.

The fact that the Fed, the BOE and the ECB are all pulling liquidty at the same time, in the middle of a crisis, is not likely to be a coincidence. I'm not sure what the game plan is here, but it doesn't look good for asset values or the economy overall.

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