There is doubt we are in a perfect storm of global financial problems; the credit crisis, the bank liquidity crisis, rapid depreciating value in housing markets (globally), inflation, high oil costs, high food costs, growing trade account deficits in most western countries. This storm could just be the precursor to widespread damage of the global financial system, in other words in the wake of this storm, there is going to be a lot of rubble.
The Central Banks of the world have all in some ways taken their cue from the US central bank; when the Federal Reserve made a move, the other banks followed. There hasn’t really been a decoupling from US reserve bank policy. Most of the central banks have copied a similar patten of the US Fed, others have quickly increased interests rates to contain hyperinflation, the countries that come to mind are the commodity export powerhouses Brazil and Australia. But both the Reserve Bank of Australia (rate set at 7.25%) and Brazilian Central Bank (rate at 12.25%) have had absolute no choice but to increase rates, even though slowing domestic growth and consumer sentiment is down. More so in Australia as consumer confidence is at a 16 year low. Both economies may be slowing rapidly, namely Australia.
So with a minority of countries having larger spreads on interest rates compared with the majority with low rates. It is an interest rate conundrum that the central banks face with global inflation and a rapid slow down within the global economy. The central banks of the world are either stuck with low interest rates or high ones. Like the US Federal Reserve, most central banks will hold rates indefinitely and hope that inflation is brought down by slowing economies or a global recession. Of course this is a false dichotomy, as oil, like certain food stocks namely wheat, rice and soy are now scarce commodities.
But current runaway inflation is also blamed on the extremely low US dollar which now sits on the dollar index of 0.72 (refer to *graph, click for larger image).
The de-pegging on the USD is very close now, if the European Central Bank does increase interest rates, which they will do; on the escalating inflation in both the European Union and Asia. As I mentioned in my blog post ‘Inflation and the EUR, the USD will further decline – ‘buy’ signal on the EUR’ – Europe has been put in a precarious position with interest rates and inflation, the ECB may have no choice but to increase rates on the back of the declining USD.
There is a very probable chance the USD will be de-pegged from the Saudi Riyal. The ECB will just grin and bear a weak USD, as Europe will tip in to a severe recession – which was unavoidable.
The depegging of the USD from the Saudi Riyal will inevitably cause the USD to collapse further in the short term, this could essentially depress US treasuries and we may see a massive sell off off the USD, namely from China – so long term collapse may be invertible, unless the Fed in an emergency meeting increase interest rates. In my opinion, if the US enters a stagflation depression (severe recession with rising costs), The Fed may cut further from their 2% (Ben Bernanke has indicated through speeches and thesis on the 1920′ 30′ Great Depression that a lack of liquidity was the reason the depression was as severe as it was) . This could essentially send the US dollar into a currency crisis as the world will shift the peg from the USD to the EUR, or a basket of currencies.
This would leave the US economy in a very serious situation, a depressed economy and a currency with no purchasing power or trade power.