The illusion of control, shattered

Since Western central banks of problematically high inflation countries, beginning with the Fed and the BoE, wrang the inflation which had built up over the 1970s from their systems in the early 1980s, there has been a belief that they were somehow in control of our economic destiny. There were a certain set of plausible economic scenarios which "would never be allowed to happen." 

After the 1987 stock market crash there were widespread fears of a return to the 1930s style depression. Greenspan slashed interest rates and injected liquidity into the system. It worked like a dream. Not only was the anticipated economic collapse averted, the market closed the year in positive territory. The tone for the next twenty years had been set. 

By the time of the Asian crisis culminating in the collapse of LTCM in 1998, the tried and tested remedy to any economic problem had become simple - slash rates. Again, it worked like a dream as stock markets and economies not only recovered, they bubbled. When those bubbles burst widespread interest rate cuts becan in 2001 cushioned the fallout. The world marvelled at how shallow the recession had been in the face of significant post-tech-bubble headwinds, and birth was give to the housing bubble. 

But this bubble was different. It was the bubble of last resort and the fallout has been larger than anyone foresaw. And now we've had bank bailouts, insurance bail outs, mortgage nationalisations, TARP relief programs ...  even coordinated rate cuts. Yet the desired effect has been missing. Market falls have turned into market freefalls since the coordinated central bank action because it feels that despite having used up our ammo the monster is still stalking us.

A few days ago I wrote:

"It feels that the only thing preventing all out collapse at the moment is the prospect of some sort rate cut. Soon even that prospect will be exhausted and one feels there will then be nothing holding up the market."

Maybe the 1987 crash wouldn't have led to an economic collapse afterall. The stock market rose because it was going to rise not because Greenspan cut rates. And in 1998, when LTCM bust, the economy did OK because the economy was OK, not because Greenspan cut rates. But it didn't matter. The perception was that central banks and policy makers more generally were in control. Risk assets were peceived to be butressed by different versions of the "Greenspan put" and perception is reality. 

But whereas the inflation scare caused by sharp recent rises in food and energy prices hinted at the underlying truth, the finanancial implosion of the last few weeks has made it obvious. The perception has now been terrifyingly altered. Central banks aren't in control afterall.