Panic Move by the Fed

John Browne
Tuesday, Jan. 22, 2008

This morning the Fed announced an emergency rate cut of 75 basis points to 3.5 percent. It was a great surprise to most investors.
The Fed meeting was the first emergency meeting since Sept. 17, 2001, following 9/11.

But, our readers will not be that surprised. For they will remember that I have been calling for major and urgent Fed rate cuts since the early summer of 2007.

Indeed, as I said last week, I felt that our Fed would make a major rate cut once it saw the new GDP figures for the fourth quarter of 2007 — even an emergency cut, before their scheduled FOMC meeting next week.

And yet, only last week, our leaders were telling us all was OK. What happened?

Well, our readers will also remember we have always disputed the commonly held view that our American economy had somehow "decoupled" from the rest of the world.

In other words, the idea that a fall in consumer demand by the great American consumer would somehow be offset by demand from fast-growing economies in the rest of the world.

On the contrary, I have maintained that, despite the rapid growth of other world economies, those economies have relatively little domestic demand. And, what domestic consumer demand they do have is still quite small compared to the massive total demand of the American consumer.

In other words, I still believe that, economically speaking, if America sneezes, the world will still catch a cold.

Surprise, surprise, over the long holiday weekend here in the United States, news filtered through that a major French banker had made a statement agreeing with me — that decoupling wasn't real yet.

As a result, all of the major stock markets in the world took big hits yesterday.

London had its biggest drop since 9/11. The German DAX 600 is down 20 percent this year.

I understand 43 of the 52 stock markets around the world tracked by CNBC are now showing double-digit losses for the year so far.

This worldwide carnage on the world's stock markets apparently shook the Fed out of its state of public denial of recession and prompted action.

But a major fear for our Fed was that a big rate cut would send our dollar into a tailspin. But the news that the U.S. had not decoupled from the world gave Fed Chairman Ben Bernanke some vital wiggle-room.

Evidence that the U.S. does still affect the world indicates that a recession in America threatens most major economies in the world with recession, too, which will eventually bring downward pressure on their interest rates.

This must have caused great relief to Ben Bernanke. It was a most welcome opening. He had room to cut rates and to do so by a relatively large amount — in fact, it was the largest Fed cut since October 1984!

As our readers and those who have seen me on CNBC's Larry Kudlow show will know, I have been calling for major rate cuts, even down to 1 percent!

Well now we are on our way, at long last! But, it is late, and thus will both deepen and lengthen any potential recession.

The other limitation on Bernanke's movement is that a major rate cut may be interpreted as panic.

Is it a time of panic?

Certainly not for our readers, who will have been very well prepared.

But, I have to say that I have just heard the normally bullish Jim Cramer announce on CNBC that this is the worst economic situation since 1932!

Even Treasury Secretary Paulson has just been interviewed on CNBC saying that. "There is evidence that our economy has weakened markedly in recent weeks."

In addition, the futures market is indicating a near certainty that our Fed will cut another half percent at the next FOMC meetings at the end of this month.

But, as I have said repeatedly, I feel these rate cuts will prove to be too little, too late to avoid a very damaging recession.

But at least the Fed is doing the right thing — at long last!

I expect further rate cuts and that other central banks will hopefully soon follow suit.

We should be grateful for small mercies.

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