The Short View: Central banks’ aid
By John Authers, Investment Editor
Copyright The Financial Times Limited 2007
Published: August 9 2007 23:29 | Last updated: August 9 2007 23:29
In the long run, economies grow, stock markets go up and, as Keynes said, we are all dead. The long run looks after itself. The problem is the short run.
After another frenetic day of trading on Thursday, which again saw the kind of movements and volumes that normally occur in weeks, it was clear that it is the very short term that is at issue.
Bad news from Europe dominated the day. First, BNP Paribas closed three investment funds to withdrawals, blaming the “complete evaporation of liquidity” in US credit markets. Then the European Central Bank intervened to provide liquidity after the rates at which banks can borrow overnight shot up.
Neither had anything to do with the long-term dynamics of the world economy. The ECB’s unprecedented intervention came within days of a clear signal that it will raise lending rates next month, as part of its fight against inflation. Judging by futures markets, the ECB even persuaded traders that its anti-inflationary zeal remained intact, even as it offered money to any bank that asked for it.
Thus it was a successful intervention. Stocks sold off, as was inevitable after scary news, but the losses were limited. European equities remained far above their lows of a week ago. Several analysts made glowing reviews of the bank’s actions.
But within hours there was an afternoon “flight to quality” on Wall Street, setting up what will likely be an exceptionally tense opening in Europe on Friday.
Wall Street’s new fear is that another source of short-term liquidity is in danger. Yields on asset-backed commercial paper, used by companies to raise overnight funds, hit six-year highs. This is more contagion from the subprime debacle: buyers took fright, because mortgage-backed bonds are often used as collateral.
If markets get through their short-term problems, with or without aid from central banks, none of this prejudices the long-run picture. But they must first survive the short run.