There's still a chance to stop the rot

There's lots of talk about the financial crisis, but nobody is addressing the immediate problem

SO IT SEEMS we are not going to get a co-ordinated cut in interest rates from the G7 countries after all. The only surprising thing about this admission from Alan Greenspan and other central bankers this week is that the markets should ever have believed it likely, or even remotely possible, in the first place.

Yet the effect of the US Federal Reserve Board chairman's words on the markets was devastating. Suddenly it seemed that the one policy response that would put a convincing floor under Western equities had been ruled out.

Is this a fair assessment? Yes and no, seems to be the answer. Yes, in the sense that the crisis in the international economy demands immediate action, and no, in that there is still a chance, albeit a remote one, that central bankers might be sufficiently alert to take it.

The first thing to be clear about is that, while Mr Greenspan ruled out any thought of co-ordinated cuts, he didn't say the Fed itself would not cut. No central banker would allow himself (or very occasionally herself) to be dragooned into cutting interest rates unless they thought there was a significant risk to their own domestic economies.

There appears to be no immediate necessity for a cut in Euroland right now, as Hans Tietmeyer, the President of the Bundesbank, has made plain. In Germany and France, short-term rates are already as low as they sensibly can be given the need for rates across Europe to converge in preparation for the single currency.

In Japan rates have been shaved to a level where they can hardly fall any further, and in Canada rates cannot be cut while the currency remains under such pressure.

In other words, the only G7 countries where there might be a reasonable case for cutting rates are the US and the UK. Here, that case has already been acknowledged by the Bank of England's Monetary Policy Committee, which has said it realises that the crisis in the international economy might increase the risks of inflation falling below target.

The Prime Minister, who is admittedly not meant to have any say in interest rate decisions any more, is reportedly also throwing his weight behind demands for a cut.

Mr Greenspan has also hinted at lower rates in another speech now forgotten in the rout. "It is just not credible that the US can remain an oasis of prosperity unaffected by a world that is experiencing greatly increased stress," he said the other week. For that, read that the Fed will cut rates if the US economy shows signs of weakening, as undoubtedly it will. In summary, rates look set to fall by the end of the year, both in the US and the UK, if not the rest of Europe. The big question is whether this is going to be enough.

I would suggest that the need for action is much more urgent. Across the US, growth in corporate profits is slowing to a snail's pace. In the UK the position is already much worse. Manufacturing has been in recession for some months, and even in the service industries there is now a sense despondency and gloom among the chief executives. Profit warnings and downgrades are multiplying with alarming speed. With the warning from Alcatel this week came evidence that continental Europe, which is meant to be on the upswing in the economic cycle, is not immune either.

I would not have argued the case for a UK rate cut a few months ago, but the Russian crisis has added a new dimension to the meltdown in emerging markets, and it should be acting as a wake-up call to policy makers everywhere.

For a while the crisis in the Far East seemed to be having a beneficial effect on the West, with cheap imports keeping inflation low and the flight of capital to safety propelling stock markets to new highs.

But now, and perhaps inevitably, the crisis is beginning to strike at our own markets, too. Big Western losses in the Far East and Russia are causing a much more widely based risk-averse climate to arise, both among lenders and investors. We already see evidence of this in plunging equity values, and we are beginning to see it in the onset of what some bankers regard as a very serious credit crunch. There has been a general drying up of liquidity in all parts of the wholesale market. This has yet to hit ordinary overdrafts, but make no mistake, unless action is taken, and with dispatch, it will.

In itself, the fall in stock markets is going to have a significant negative impact on the real economy by making people feel less wealthy and causing a ripple-down effect into consumer spending, housing, construction and other industries.

This is particularly the case in the US, where most households are direct investors in the stock market. But it is also going to have its effect on savings markets throughout the developed world. One example suffices - annuity rates once again hit a new record low this week. While the stock market was rising, this fall in yields did not matter so much as it was compensated for by prior growth in capital. With equities now in full retreat, it matters a lot, for it means that capital is being eroded at a time when returns are falling. Taking all this together, this is not a good time to become a pensioner.

Nobody yet knows quite how serious the full effect of all this is going to be, and of course central bankers are right to be cautious and to set some of the more alarmist talk about a global slump in the making in context.

But is it really worth taking the risk of inaction? If there were still very serious inflationary dangers in the system, it would be easy to argue that it was. But actually the balance of risk has moved sharply from the inflationary to the deflationary side in the last month. This requires a different mind set from that of central bankers, and a changed set of priorities. Unfortunately, and despite the ghastly lesson of Japan, which has lived with deflation for many years now, the necessary evolution in thinking is proving remarkably slow.

There's lots of talk among world leaders and policy makers about how to respond to the crisis in the international economy. Most of it is reasonable enough; it's about persuading bankers to roll over their debt, it's about how to introduce greater stability into financial markets without imposing capital controls or otherwise interfering. And it is about improving the transparency of developing economies and bolstering their banking systems.

This is all well and good, but while we are learning the lessons of the crisis and devising suitable long-term remedies, nobody is addressing the immediate problem. There's still time to stop the rot. Even a quarter- point cut by the Fed might be enough to bolster sentiment, although in truth it might require more than that. In taking such action, we may never know whether it was really necessary. It is still possible that the US and European economies are strong enough to weather this storm without such action. But once again, is it really worth taking that risk?