Stock and financial markets tremble

Aug.17, 2007


In human terms and the tragedies of nature and humanity the earthquake in Peru is the real story of the day.Our sympathy to its victims and I hope that Canada , the US and other hemispheric neighbours do as much as possible to help Peru cope with this crisis.


But given the central role which financial markets play in the modern globalized capitalist world the current volatility and widespread fear in the financial and stock markets is also a story that cannot be ignored. If the nervousness continues and a wide sell off develops and spreads upon further bad news from the American economy and the sub-prime bubble bursting - a classic bubble in the tulip bulb tradition- there could be real trouble ahead for many of our central banks who have been obsessed over inflation and appear to have overlooked that interest rates should have been cut rather than raised to stem the loss of values and ensure that the air was let out of the bubble in a slow and steady manner.
But it appears that the central bank Governors are slow learners and only react when the damage is irreversible. The usual argument in defense of this approach is moral hazard.

In other words why should the central banks bail out bad investors who have shown a particular lack of historical knowledge and prudent risk taking in fueling the sub prime market.

The answer is quite clear. If they refuse to bail out some of these investors and limit the damage the sub -prime crisis will much like an earthquake whose shock waves spread a long way from the epicentre spread   its nasty consequences far and wide in the global market place.

There are a number of interesting scenarios being played out.In Asia the Australian central bank and the Bank of Japan have both intervened to supply substantial liquidity to the financial markets.

According to a very useful report in Bloomberg
news written by R. Harui in Singapore and S.White in Tokyo   the Bank of Japan has injected over 1 trillion dollars ten times this year in order to supply adequate liquidity to the financial markets.

The Australian, Canadian and American central banks have also injected substantial liquidity.

The yen for its part continues to rise against the Euro and the US dollar. It is speculated that the yen may rise further against both currencies.It has appreciated from 118.4 to the dollar to 112.4 a week ago.

The Australian dollar on the other hand has lost substantial value against the US dollar falling to as low as 78.69 cents from over 87 cents.

This has happened despite the fact Australian overnight rates are 6 % versus just 0.5 % in Japan.

Many traders have shifted from predicting no rate cuts by the Fed to predicting a 65% likelihood that rates will be cut 50 basis points at the next setting in September. If this does happen it will leave the Bank of Canada looking quite foolish in its decision to raise rates in their recent decision.

There will be interesting days ahead in the financial and stock markets and around the policy tables at the central banks worldwide