RBA cuts rates by 1% ... events are moving too quickly ... we're watching a policy mistake

A stabilisation of sorts this morning. Asia is still largely softer although there are pockets of green - Korea, Taiwan and Australia are all higher by a percent or so after the RBA surprised the market with a surprise one percent cut, from 7% to 6%. 

There has been the hope of a coordinated cut in recent days ... rate cuts are now the only conventional weapon left in central banks armoury and a globally coordinated move would likely give more bang than individual stand-alones. Who knows if such a move would stave of economic collapse, and God help us if it doesn't - but now is surely the time to try. 

Nevertheless, the BoJ this morning opted to keep rates on hold saying only that economic growth was "sluggish" and likely to persist "for some time given the slowdown in overseas economies is becoming clearer ..." 

You can't help feeling that the world economy is changing more rapidly than its participants can fathom. With his company's stock down 18% yesterday after indicating it stood ready to cut steel production by 15% if needed, Lakshmi Mittal said:

"I believe this situation is short-lived, all of us hope it is short-lived. When this situation is behind us, things will improve.'' 

Only a few months ago the same Lakshmi Mittal said: 

“I can say with considerable certainty that the volatile years of boom and bust are now relegated to the past."  

More serious is that policy makers haven't quite woken up to the problem and the mistakes are compounded an already dire ennvironment as they have every financial crisis in history. In 1930s America it was protectionism, overly tight monetary policy and higher taxes. In Japan in the 1990s it was overly tight monetary policy, bungling financial reform and eventually, higher taxes. 

Today, we have a situation where market interest rates are tightening significantly. Monetary conditions are considerably more restrictive than this time last year, or than this time last quarter, or even at this time last week and the economy is deteriorating lockstep. Yet yesterday, Mr Evans at the Federal Reserve said:

" ... the inflation outlook remains a risk ... energy and commodity prices are notoriously volatile, and could rise again. More importantly, there is the risk that persistently high rates of overall inflation will boost the long-run inflation expectations of businesses and households, and thus become embedded in their actual price and wage setting behavior."

I'm going to put my neck out here, but I think Mr. Evans just might be wrong. The world is already unrecognisable to that which existed two months ago. It is a credit desert and like it or not, economies require the free flowing of credit to function properly. The complete siezure of credit will completly halt economic activity and it is no longer sensationalist to point to the increasingly real risk of depression, especially with central bank attitudes like this. By allowing monetary conditions to tighten so extremely without even trying to lower policy rates we are seeing a policy mistake and history clearly shows policy mistakes make bad situations worse.

Speaking as someone who is structurally bullish of energy, it's difficult to see a doubling of prices while we're looking at a potential debt deflation. This already savage and distressed world-wide financial deleveraging is accelerating and spreading from the US to the rest of the world. Unchecked, the end game is a broken international trading system, an increasingly traumatised world labour force and a radically altered political climate in which international relations will be more strained than they have been since the end of the Cold War. This is the future. Yet policy makers are still looking backwards. 

There is a chance of oil prices doubling in the next twelve months, as there is a chance that a piano falls through the roof of my house, through the office ceiling and lands on my head. There is a much higher chance that this time next year there will be street demonstrations demanding jobs and an increasingly vocal xenophobic nationalism growing in developed and emerging economies alike. Politicians rarely cover themselves in glory in such times.

But few things are as dangerous as a bad idea which is popular. From the Great Deprssion in the 1930s to the lost decade in Japan's 1990s, policy mistakes have been absolutely key ingredients in making bad situations worse. The current obsession with moral hazard and second round price effects echo's, albeit less extremely, the prevailing attitude in the 1930s when Treasury Secretary Andrew Mellon confidently advised Herbert Hoover in 1931:  

"Liquidate labour, liquidate stocks, liquidate the farmers, liquidate real estate. Purge the rottenness out of the system. High costs of living and high living will come down... enterprising people will pick up the wrecks from less competent people."