March 18, 2008 | posted by Michael Baxter in US economy |

Today’s the day the Fed seems likely to announce the most spectacular cut in interest rates seen for a very long time.   We know rates will fall, that appears to be a given.    But how big will the cut be? Judging by its decision to cut the discount rate  on a Sunday – an unprecedented step – it seems likely it will be a very big cut indeed, perhaps a full percentage point.   

Even more significantly, a growing chorus of voices is now predicting that rates will fall to zero per cent soon.    And yet, while the choir of economists sing out their praise, economic gods fall.  The mighty dollar, just like Uranus, the grandfather of Zeus, has been castrated. But now, even the heir to the crown, the rate of interest, seems to be confined to the underworld.

In Greek mythology, Zeus rose to pre-eminence after killing his Father, Cronus, who had previously castrated his own Dad.    The ruling family of Ancient Greece were clearly a dysfunctional family – but then it appears much can be said about the family of economic policy tools that for so long served us well.   The dollar appears to be in freefall, the rate of interest weapon appears to have become blunt, and its yielder, the US Federal Reserve, impotent.

All of a sudden, a nasty word has been dragged out from the economist’s lexicon; recession is old news, all of a sudden it’s the ‘D’ word – Depression.   Parallels  with 1929  have become the staple diet of press reports.

Yesterday,  Michael Taylor, a senior market strategist at Lombard was quoted in the Independent as saying, “We have all been talking about a 1970s-style crisis but as each day goes by this looks more like the 1930s. No one has any clue as to where this is going to end; it’s a self-feeding disaster.”

Recently, Alan Greenspan, a kind of prophet for the old economic gods, warned that we are facing the most serious financial crisis since the Great Depression.  It’s all very well making these warnings, but Greenspan himself was really little more than a one trick pony, he was an expert at playing with the rate of interest – but today, it appears that is no longer enough.

For despite the near certainty of a dramatic cut in interest rates today, despite predictions that rates could fall all the way to zero, the gloom seems never ending.  The collapse of Bear Stearns is a truly dramatic event – this was a much respected, established symbol of US financial strength.  
 
We are familiar with the arguments to explain the crisis.   The banks have stopped trusting each other, they have stopped lending to each other, therefore they will soon stop lending to customers.  And why is that?  Cut through the crisis, say many commentators, and you will find greed as the main cause of this problem.  This morning on the Today programme, for example, a story was told of how one banker did a dodgy deal – but said all he cared about was his bonus.

So perhaps then the problem is that bankers’ remuneration is not appropriate – they are rewarded for short-term gains, regardless of the longer-term implications.

But even that analysis seems to run only skin deep – there is more to this crisis than that.

Again on the Today programme, reference was made to the dotcom crash and how  Elliot Spitzer hounded the financial institutions who gave out such bad advice during that period.  The prediction goes that we will see a similar pattern  again – as the credit ratings agencies and banks find themselves in the full blast of a public backlash.

But parallels with the dotcom crash miss the point.    Just as we find Mr Spitzer was no saintly crusader fighting the cause of the oppressed, rather, he was as tainted as were the original crusaders, then the true reality should dawn upon us.

For all its irrationality, the dotcom boom surely laid the foundations of a new economic era – the Internet is transforming business, it’s surely a major factor behind globalisation, and is surely a major reason why we have had such low inflation in recent years.      Without the dotcom boom, maybe the global economy would not have expanded anywhere as fast as it has done.

And now it’s time to observe the real truth, the real reason behind this crisis.  When we do that, we find that actually there’s an altogether more fascinating, and for the longer term,  more optimistic tale.  To read this account of the real forces that lie behind this crisis, read the next article.