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Warnings from central bankers are more often than not taken with a pinch of salt and in January 2007, European Central Bank (ECB) President Jean-Claude Trichet cautioned that conditions in global financial markets looked potentially "unstable", suggesting that investors needed to prepare themselves for a significant "repricing" of some assets. Trichet said at the World Economic Forum in Davos, Switzerland, that the explosion of structured financial products and derivatives had made it more difficult for regulators and investors to judge the current risks in the financial system. "We are currently seeing elements in global financial markets which are not necessarily stable," he said, pointing to the "low level of rates, spreads and risk premiums" as factors that could trigger a repricing. "There is now such creativity of new and very sophisticated financial instruments . . . that we don't know fully where the risks are located," he added. "We are trying to understand what is going on - but it is a big, big challenge." Stanley Fisher, Governor of the Bank of Israel wondered at Davos "who takes responsibility for the [financial] system" at a time of crisis, particularly given that the "hegemony of the US is diminishing."
On Thursday August 9th, the Euribor inter-bank rates, which banks charge each other for short-term lending, surged on news that BNP Paribas, one of Europe's biggest banks, had said that a "complete evaporation of liquidity in certain market segments of the US securitisation market" had prompted its decision to stop redemptions from the three funds, and further investments. Collapse of demand for some forms of securitised debt made their assets impossible to value, the bank said.
On the same day, the ECB swiftly responded by pumping additional liquidity of €95bn into the Eurozone banking market. In succeeding weeks, the Bank of England Governor Mervyn King had to reverse his tough position on bank funding following the run on Northern Rock Bank and in the US, the lowering of the discount rate to allow banks get emergency funding at the Fed's so-called "discount window," failed to have an impact. By December, the other central banks had moved towards the ECB position of auctioning funds to the markets against a wide range of collateral, rather than expose individual banks to the stigma of seeking emergency funding. Euribor (European Inter-Bank Offered Rate) and Libor (London Inter-Bank Offered Rate) have moved down slightly and nobody knows when credit markets will return to normal. When the Euribor 3-month rate was last above 4.9% in December 2000, the benchmark rate was 4.75%. Today, the benchmark rate is 4.0% The creation of the Euro in 1999 was a remarkable achievement but many including then Federal Reserve Chairman Alan Greenspan were not optimistic about its success, which Greenspan disclosed in his memoir The Age of Turbulence.
Eleven countries (now thirteen) with contrasting economies subject to a "one-size-fits-all" monetary policy and its first President Wim Duisenberg, (1935- 2005), always prone to unnerve markets with off-the-cuff remarks to reporters, provided the doubters with some fodder as the new currency fell in value against the US dollar. More than 12 million jobs have been created in the Eurozone in the eight years since the creation of the Euro in 1999. "In the eight years before that, less than three million jobs were created in the same countries. More than 12 million jobs in eight years. That’s more than the United States over the same period. In France, it’s the same thing: two million jobs after the Euro, 500,000 before, in the same preceding eight-year period," Jean-Claude Trichet said last August. Trichet said that those who say that the Euro acts against employment don’t have the figures to back up what they are saying. "I’m not saying that it is the Euro by itself which has created all these jobs – it’s of course the efforts of all our fellow-citizens, the bold, creative spirit of our businesses, the economic reforms which have been carried out, but it’s also, clearly, the monetary stability that we have brought to a whole continent, to over 300 million people. What’s more, there is a significant consensus worldwide which regards price stability as a necessary condition for sustainable growth and sustainable job creation, because it maintains purchasing power and boosts the confidence of savers and investors. Price stability in itself isn’t enough, but it is necessary," he said. In an interview with EuroNews on December 20th, Trichet put the latest figures for new jobs created in the Eurozone since 1999, at 14.8 million.
Last September, at a dinner to celebrate the 50th anniversary of the German Bundesbank, Jean-Claude Trichet said: "With regard to the Bundesbank, I think that it is fair to say that its foundation provided not only Europe but also the rest of the world with a very good example, and indeed a role model, of central banking. The trademarks of this role model are monetary stability, independence and credibility. The Bundesbank has embodied them from its inception, and, today, they are recognised all over the world as essential for monetary policy to deliver price stability and, in this way, to support sustained economic growth and job creation." He also said that the clear objective of price stability and the independence from executive branches, however, were not the only necessary conditions for the success of the Bundesbank as an institution. The additional and decisive condition has been the credibility it gained with the German people and with global financial markets. Credibility is not something that can be installed by decree, it has to be earned, Trichet said. One of the key architects of the European Monetary System and the Maastricht Treaty, Jean-Claude Trichet (b. 1942: ECB bio) today heads one of the world's top central banks, which has earned its credibility; tempered by the fire of politicians of Left and Right when Governor of the Banque de France, in the 1990's, which gives him the reserves to "fiercely" defend the European Central Bank, against political interference today and look beyond the temptation of short-termism. Mr Euro - Jean-Claude Trichet, is the Finfacts Person of the Year 2007. In defence of ECB independence, during the ECB's press conference following the decision to keep the key interest rate on hold on Sept 6, 2007, in response to a journalist who was fed news that French President Nicolas Sarkozy had claimed that the Governing Council decision showed that the ECB is coming around to his view, Trichet said firmly: "We are independent." He also said that Article 108 of the Maastricht Treaty prohibits politicians from trying to influence its decisions. In a slap-down to Sarkozy, his compatriot, Trichet said that interest rates would be higher if politicians were involved as the markets would not ascribe the same credibility to them as it does to the ECB. More than a year before in June 2006, Trichet was asked at a press conference in Madrid, why he hadn't responded to a letter from Jean-Claude Juncker, Luxembourg Prime Minister and Finance Minister who as Chairman of the Eurozone Finance Ministers' group, the Eurogroup, had sought more direct involvement in ECB interest rate decisions. The media had dubbed Juncker "Mr. Euro." "I am Mr. Euro," Trichet told journalists at the ECB's monthly press conference. In September 2006, after the meeting of Eurozone Finance Ministers in Helsinki, Trichet underscored the point. Standing before the assembled journalists, with Juncker just a few feet away and Joaquín Almunia, the European Commissioner for Economic and Monetary Affairs, between them, Trichet went further. He pointed out that it is his signature that is on each and every euro note. And he twice referred to EU law, which states not only is the ECB not permitted to ask governments for advice on its monetary policy decisions, governments are not permitted to give the independent central bank instructions or even to try to influence ECB policy. It is easy to be a cheerleader for cuts in the ECB's key interest rate of 4.0% but the credit crunch has imposed the equivalent of 3 ECB interest rate hikes on business (see Euribor data above) and also on the residential sector. Nobody knows when the situation will revert to normal. Last week, Irish Life & Permanent raised mortgage rates and said that a sustained high Euribor rate will seriously damage its performance in 2008. In the New Year, Irish home loan lenders are expected to hike mortgage rates because of the elevated Euribor rate.
The impact of the China Effect, which reduced inflation in the Developed Countries over two decades, through falling goods' prices, together with the flow of direct labour from Eastern Europe after the fall of Communism, is waning, coincident with food and energy inflation pressures arising from demand pressures in Asia. In November, Eurozone inflation rose to 3.1% compared with the ECB's target of "below but close to 2%." A financial service economist may see merit in an early ECB rate cut to boost his employer's sales but a central bank has more serious and longer-term responsibilities. Besides, past experience shows that once inflation expectations rise in an economy, it is very difficult to return to a lower level. The principal risk now for the Euro is that it will become too successful - in effect foreign holders of US dollars would switch to Euros, boosting it value and imperilling the competitiveness of Eurozone tradable goods and services. English writer George Orwell also wrote that: "All political thinking for years past has been vitiated in the same way. People can foresee the future only when it coincides with their own wishes, and the most grossly obvious facts can be ignored when they are unwelcome." Fortunately, while the world of central banking is not one of easy choices, decisions can be made that are not compromised by political self-interest and the 318 million citizens of the Eurozone are fortunate in having Jean-Claude Trichet in charge of their central bank. RELATED Eurozone Annual Inflation rose to 3.1% in November - the highest since 2001 How Goldman Sachs made money from US subprime mortgages on the way up and down
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