Consider This: By 3 Wood

The EU and the U.S. are at loggerheads over monetary policy



MORGAN STANELY WARNS OF CATASTROPHIC EVENT AS ECB FIGHTS FEDERAL RESERVE

"The clash between the European Central Bank and the US Federal Reserve over monetary strategy is causing serious strains in the global financial system and could lead to a replay of Europe's exchange rate crisis in the 1990s, a team of bankers has warned.

"We see striking similarities between the transatlantic tensions that built up in the early 1990s and those that are accumulating again today. The outcome of the 1992 deadlock was a major currency crisis and a recession in Europe," said a report by Morgan Stanley's European experts.

Just as then, Washington has slashed rates to bail out the banks and prevent an economic hard-landing, while Frankfurt has stuck to its hawkish line - ignoring angry protests from politicians and squeals of pain from Europe's export industry."

Joel Grey & Liza Minelli in Cabaret 1972

Translating this to English, here's what this means:

In monetary policy, you have a "Sophie's Choice" when things are slowing down. You can either expand the money supply and cut interest rates to try to grow the economy at the risk of higher inflation, or you can contract the money supply and raise interest rates to hold inflation down at the risk of tanking the economy. The U.S. has taken the first option, the UK and EU the second. Additionally, not to blow you away with economic technicalities, but the way the EU is set up makes it practically impossible for the European Central Bank to expand or contract the money supply efficiently. If they try it they create arbitrage between the various EU countries in the euro.

So, the European Central Bank has only half the monetary weapons that the U.S. Federal Reserve Bank does to deal with tough times. It's like trying to play golf with one hand for them. The upshot of this is, when the macro economy is slowing, the EU (and the UK to some extent) tend to stand on the sidelines and wait on the US to fix the global macro economic problems, hopefully that does not involve some economic pain for them. Unfortunately, that way does not exist.

The best possible solution to all of this is to increase productivity and grow our respective economies out of this downturn, but the more socialism you have the harder it is to increase productivity.

Sooner or later, it all comes back to Adam Smith.

~ 3 Wood