Let?s get this clear. This is not going to be the last of the crashes in global economy. Despite the titanic scale of the present disaster, there is just no way the next one can be anything more than ten or at best twelve years off. Booms and busts are not peculiar to the capital markets, only more spectacular. No one at this point would care to remember the bust in the commodity cycle that happened in 1997, which almost wrote the epitaph of most of India?s steel companies.
But having got that out of the way, the most impressive spectacle of the present crisis is the way the central banks of major economies are shaping up to tackle them. This is by far the biggest change in the way the present crisis has been handled in the US and EU, the two zones where the impact has been the most severe. This is not the same as the lock the door and hope the fire does not travel this way approach that characterised the response to the 1997 East Asian crisis. Sure, in that case, the trouble did not occur on Wall Street or Canary Wharf but the difference in response by the central banks this time is far different qualitatively.
The most expressive demonstration of this is the international calibration that the central banks demonstrated on Monday, when the bottom literally dropped out of the financial markets.
The US Federal Reserve added $70 billion in reserves to the banking system through repurchase operations (repo) to ensure a run against liquidity. The European Central Bank, the Bank of England and the Swiss Central Bank duplicated the effort. On Tuesday, the Bank of Japan added 2.5 trillion yen or about $24 billion to the hat, while the People?s Bank of China cut its benchmark one year lending rates for the first time in six years to 7.20% from 7.47%. The Reserve Bank of Australia has also injected $1.5 billion to the pool.
Further on, the Bank of Korea (South Korea) has already assured investors it would provide foreign currency liquidity through the swap market. And for the first time, nearer home, there are reports that RBI may cut rates despite inflationary concerns to ensure that growth concerns are not damaged severely.
There is absolutely no doubt that a possible manic Monday was averted because of these measures. Each of these funds flow taken in isolation, say over this week, would have been a case of too little too late. Let?s make no mistake: the crisis is far from over. Till the red ink on the balance sheets of large global banking, hedge funds and investment banks disappear, the convulsions will continue.
But this is not the telling lesson that central banks will take away when temperatures cool in global markets. Putting in money to douse the heat is the easiest part of central banking. Instead, there are indications that these banks are coming to grips with the cascading impacts of the failures of the mega financial corporations. The answers straddle political boundaries and therefore in the past the central banks have avoided taking a call on them. But that option is past.
Speaking at an Indian Express forum recently, Percy Mistry outlined this concern succinctly. The liquidity problem that struck Northern Rock in England had nothing to do with its banking practices. It was a conservative bank that was hit because of the financial maelstrom in the US. As entities like Lehman Brothers go down, the possibility of similar convulsions in other economies pretty far off from the US becomes more plausible.
The central banks have therefore begun to collectively unravel the implications for their domains of disturbances developing elsewhere. The coordinated reaction on Monday and Tuesday is a sign of a change in central banking practices that will in the next few years turn the most basic wisdom of central banking on its head. Central banking decisions are likely to become more collective. This does not mean financial crises will not come visiting. As bright people learn lessons, they will develop more sophisticated products to hedge their profits. Derivatives will become sharper. But the central banks will turn their energy to minimise the cascading impact of troubles rather than trying to bail out one or the other company, which is often based only on political logic.
This is therefore the next spell of globalisation that could soon emerge from this round of crisis. No central bank and no economy will therefore be able to take a contra position to fend of crisis. It is quite on the cards that the central bankers will be forced to start exchanging information among themselves on a more robust scale than the usual bunch of statistics that are couriered across. For starters just check out from the list above, just how many of the central banks overcame high inflation concerns this week to offer more liquidity.
subhomoy.bhattacharjee@expressindia.com