When mandates meet recessions, mandates are tossed out the window. It’s a brave new world for the ECB as Trichet Extends ECB Power, May Cut Rates at Fastest Pace Ever.

Jean-Claude Trichet is extending the European Central Bank’s powers just as it gears up for what may be the fastest round of interest-rate cuts in its 10-year history.

President Trichet has pushed the central bank’s reach into the euro region’s neighboring economies as they struggle to cope with the financial crisis, and has approved record lending to banks. Economists predict the ECB will slash its benchmark rate, currently at 3.75 percent, to 2.5 percent by April after a likely cut on Nov. 6.

“The ECB is at times playing the role of lender of last resort for the whole European financial system,” said Guillaume Menuet, a senior European economist at Merrill Lynch & Co. in London. “Its mandate is being implicitly expanded.”

While Trichet’s remit applies just to the 15-nation euro region, the absence of an institution charged with financial stability across the 27-member European Union created a vacuum the ECB is trying to fill. In the past three weeks alone, it gave a 5 billion-euro ($6.4 billion) loan to Hungary, set up currency swaps with Denmark and Switzerland and increased its lending to euro-region banks to more than $1 trillion.

Hungarian Prime Minister Ferenc Gyurcsany said on Oct. 28 he’s lobbying EU leaders to allow the ECB to provide liquidity outside the euro area. ECB Executive Board member Lorenzo Bini Smaghi said on Oct. 31 the bank stands ready to help “other” eastern European countries that are “asking for our help.”

That may create problems for the ECB as the risk of possible collateral losses grows, says Natacha Valla, a former ECB economist and now at Goldman Sachs Group Inc. in Paris.

“They have challenges for the future in having a balance sheet of unprecedented size,” said Valla. “The have to know how to deal with such a balance sheet, how much capital they have to hold, what it means for risk management. There is a whole set of questions that now have to be answered.”

ECB is European Lender of Last Resort

And so the ECB became the Euro lender of last resort just as the Fed is the dollar lender of last resort. Furthermore, a quick glance shows all four corallaries of the Fed Uncertainty Principle now apply to the ECB as well although some might argue to a lesser degree.

Simply replace “Fed” in the following paragraphs with “ECB”and you have it.

Corollary Number One:
The Fed has no idea where interest rates should be. Only a free market does. The Fed will be disingenuous about what it knows (nothing of use) and doesn’t know (much more than it wants to admit), particularly in times of economic stress.

Corollary Number Two: The government/quasi-government body most responsible for creating this mess (the Fed), will attempt a big power grab, purportedly to fix whatever problems it creates. The bigger the mess it creates, the more power it will attempt to grab. Over time this leads to dangerously concentrated power into the hands of those who have already proven they do not know what they are doing.

Corollary Number Three:
Don’t expect the Fed to learn from past mistakes. Instead, expect the Fed to repeat them with bigger and bigger doses of exactly what created the initial problem.

Corollary Number Four:
The Fed simply does not care whether its actions are illegal or not. The Fed is operating under the principle that it’s easier to get forgiveness than permission. And forgiveness is just another means to the desired power grab it is seeking.

The context of “Inflation Fighting” in the title to this post should be clear, but in case not I will spell it out. I am referring to the ECB mandate that means price stability. Of course it is impossible to stay in control with such poor definitions and that is one of the problems facing both the Fed and the ECB.

Neither the Fed nor the ECB can control inflation when they does not know what it is (See Inflation: What the heck is it? if you do not know), when prices cannot properly be measured, and when productivity, hedonics, and time preference all affect prices.

The price theory of inflation has blown sky high and it is amazing how few even see it in spite of obvious central bank panic to control not inflation, but deflation.

Mike “Mish” Shedlock
Click Here To Scroll Thru My Recent Post List