Interest rates are ofcourse not the only toy central bankers have to influence the economy and inflation rates. Money supply growth is the best indicator on predicting future inflation. Money supply growth for the euro is, just like the US dollar and most of the other fiat currencies in the double digit rate, the euro, for 2007 at 12% ! That means every year there are 12% more euros in circulation. Now that is a guarantee for future price IN-STABILITY and a perfect foundation to get hyper inflation.

So Mr Trichet is acting like he tightens the market by keeping interest rates ‘high’. In reality he is opening the gates of liquidity more year by year.

And I was thinking we had our own Paul Volcker rising from the masses. I should have known better …

In the end, Mr Trichet or any other central banker/planner can only - really - start fighting inflation and bringing down pain on the masses when the masses are also - really - tired of inflation and willing to accept the pain.

Are the europeans ready to stop kricking up the enonomy with loose monetary policies? Or do they prefer to be cheated a little bit as long as everything continues to go ‘up’?

Central planners, have mercy with them. Their job was impossible to start with.

I was always under the impression that Europe was just lucky with the Euro rising against the dollar. And it would only be a matter of time that the ECB would follow the cheap money policies of the FED, destroying the euro in the process, in order to keep our economy competitive for exports.

Now that I see the inverse. The ECB consciously following a policy of tight money as to keep inflation down, I must say I start to believe again in Europe and am less inclined to convert my too valuable euro’s to somewhere else.

Thank you Mr Trichet. You are Europe’s savior.

The man is incredibly “wrong-footed”. He was in Salzburg over the weekend, and as luck would have it, his topic was “transparency”. His view was that lucid analysis, speedy action, and consensus between experienced heads is the best way to minimize contagion. Would that, Jean Claude, would that!

“In hectic times, when fear dominates, the absence of transparency fosters herd behavior and amplifies considerably the initial shock that triggered the turbulences”

“Transparency vis-a-vis investors and savers, transparency vis-a-vis surveillance authorities, appears to be the best vaccine against contagion.”

“It is always a recipe for additional difficulty to over-assess the gravity of a particular situation and therefore to over-react. But it is equally dangerous to misjudge a particular situation by underestimating its gravity and the risks that are at stake”

As I suggest above, my principal concern here is not an over-high euro (although I do think that in some specific countries, like Italy, this is already presenting problems), my worry is the danger of an excessively strong reaction in financial markets to a change of story here in Europe. The euro closed at $1.42 in US trading on Friday, largely because people anticipate a weaker US economy and more interest rate reductions from Bernanke.

But what about the eurozone economic performance, and interest rate policy at the ECB, this is the part of the story that people don’t seem to have clear yet. Bloomberg had a useful summary of the situation this morning.

*********************************************

Central bankers from Europe’s Jean- Claude Trichet to Canada’s David Dodge may follow Federal Reserve Chairman Ben S. Bernanke in an about-face, shifting toward supporting economic growth and away from fighting inflation.

Economists are scrapping forecasts for higher interest rates in the euro area, the U.K. and Canada as prospects for expansion weaken, and some even say inflation will soon recede enough to permit cuts. A similar change in outlook may delay expected rate increases in Japan.

Evidence may come this week as the European Central Bank and the Bank of England each hold policy meetings Oct. 4. While economists don’t expect rate cuts this soon, ECB President Trichet and Mervyn King, the U.K. governor, may use the opportunity to signal greater unease about growth.

What’s changing is the view of where the ECB and Bank of England go from here. Just weeks ago, the consensus was that they would only pause in their drive to push rates higher. That view was reinforced by anti-inflation rhetoric from central bankers themselves. Now, as credit-market turmoil in the U.S. spreads overseas, the pause looks more like a peak.

I’m saying something a little more subtle I think. I’m saying that Trichet knows they are too high. The same as Bernanke did. The reason he is in hiding is that he is apprehensive about what will happen when he tells everyone the plain truth. Given what he has been saying for the last year and a half I can well understand how uncomfortable he feels at this moment in time.

But I want to emphasise, the problem Greece, Ireland and Spain are having at this moment in time (and it is interesting to note that a big part of the construction boom in all three of these has been second home, in the West of Ireland 40% of the newly built properties are estimated to be unoccupied) is not to do with interest rates per se, it is to do with fear. Fear in the banking system about the consequences of having too many risky loans on the books.

I am simply saying that given that this problem exists - Austrian would probably say serves them right, let them suffer for their failings - then the ECB needs to do something, and quickly.

Whether interest rates were too high for some parts of the eurozone much earlier than now is a different question altogether which you lead into with this.

“Or are you saying that a common interest rate for all Europe doesn’t work?”

Yep. Probably I am saying this. I have argued this from the start, but…..

“The costs of disestablishing the Euro would be by far higher.”

Yes, so we have one almighty mess now. And we have to make and mend as best we can. What works for Germany won’t work for Spain and vice versa. We simply have to be pragmatic, and do the best we can under the circumstances, which is far from optimum for everyone.

Except possibly for France, since France given that it is between the extremes, probably has the most appropriate monetary policy of anyone. Which is why I think Trichet is particularly ill advised to be quarreling with the one country which can help him out of his mess right now. The irony is of course that Trichet is himself French, and everyone was worried before his appointment about undue French influence in Frankfurt. He who laughs last last best, evidently.

See next post coming later today.

Or are you saying that a common interest rate for all Europe doesn’t work? If so, what could be done? The costs of disestablishing the Euro would be by far higher.

“Stupid question, but why would falling house values be bad for those who don’t have a house? You get them cheaper, after all.”

In and of themselves obviously they aren’t. They are bad for those who have already bought. Really if you are a houseowner in Spain, if you bought before 1998 you are fine, becuase when all this is done your house should still be worth more than you paid for it.

If you bought between 1998 and 2007 then you are “exposed” in the sense that depending on how serious the contraction is, you may have a house (or flat) that is worth more than you paid for it, or you may not.

Why might this affect those who didn’t buy, well it depends whether you need a job or not, or what sort of salary you want. I mean we really don’t know at this point how far any of this will go, but if those who have bought are affected badly enough, and if you are busy trying to save, then aggregate demand may contract, and this means less jobs and lower wages. It depends. Bad weather normally isn’t good news for anyone except the carpet bagger.

Macroeconomics is a complex topic, but I would like to emphasise that at this point we have no idea how serious the situation in Spain is. I would also point out that Spain is not the only problem. It is simply and ADDITIONAL one in this downturn. The big issues are still Germany and Italy, I think.

“Secondly, if this was a bubble, wouldn’t it become worse if it were allowed to go on longer?”

Well of course. But you need to look at the whole picture here, and how having a single interest rate for everyone works out in practice. Also, most central bankers agree that it is better not to burst them abruptly. The “liquidity crunch” has thrown everything out of control a bit. That is the airplane is losing height much more rapidly than the piot should be confortable with.

And thirdly, there is no possibility that this “bubble” is going to continue having - if you’ll forgive the pun - set light to the building, it is now a question of how to extinguish the blaze with the least collateral damage possible.

Secondly, if this was a bubble, wouldn’t it become worse if it were allowed to go on longer?

Subprime mortgage lenders have been pushing up their interest rates and tightening lending criteria in recent weeks, meaning borrowers will be unable to find loans on similar terms.

In addition, many subprime lenders, such as GMAC, are now asking borrowers to put down a larger deposit of 25 per cent rather than the 10 per cent required just a few weeks ago.

So the question of increasing deposits is becoming more general than just Spain.

and In its report, S&P sets out how the squeeze, in which lenders have struggled to securitise mortgage assets into the capital markets, will lead to borrowers paying more each month. This could trigger growing numbers of home repossessions as borrowers struggle to repay loans.
“The likely scale of this upcoming effect, and the potential subsequent impact on borrowers’ payment behaviour is relatively severe by recent standards,” said S&P.

Peter Tutton, a social policy officer at the National Association of Citizens Advice Bureaux, said this put continued pressure on consumers: “Some borrowers may not be able to refinance easily and are on a tight income and may see a whopping big jump in payments.”

All of this is, of course, likely to trigger a significant downward correction in home prices in the eurozone housing boom countries. One of the most likely mechanisms in Southern Europe is via the second homes sector according to Michael Ball, a professor of real estate at Reading university and a housing adviser to the UK government.

As an example of what might happen we could look at Florida where some resorts have seen double-digit drops in the past year alone. The number of home sales in Florida dropped 43 per cent between the first and second quarters.

As I say, in Spain we are still about a year away from this, and closing fast.

So as I said at the beginning of this post, where the hell is Trichet. He still hasn’t been out making any relevant comments on the latest Eurozone data, and this in now Saturday.

“Incidentally, Antoni Jaume, how are you? ”

rather overweight… otherwise fine, if with a lack of creativity. I’ve been a long time without reading AFOE due to some bug that rendered the blog in a unreadable way.

DSW