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Fed, ECB need to tackle latest threat to growth: Terrorism

A police officer guards the southern entrance to Munich's main station
Johannes Simon, Getty Images News
A police officer guards the southern entrance to Munich's main station

Although they are managing the economies that are at different points within the global business cycle, the Fed and the ECB seem to share the same views of what needs to be done to strengthen demand, output and employment in Europe and in the United States. Both central banks are maintaining a degree of monetary accommodation reflecting the cyclical positions they are currently facing.

The Fed is ahead of the game. Having steadied the economy along a path slightly above its long-term potential, the Fed is now gradually withdrawing excess liquidity without any noticeably adverse effects on money and capital market conditions. In the U.S., bank lending to consumers has accelerated in recent months to an annual rate of nearly 7 percent, while the nonbank consumer lending -- which accounts for about two-thirds of the total lending to American households -- was exploding in May at an annual rate of 10.6 percent.

The ECB, by contrast, is still struggling to keep the euro area economy afloat. Bank lending to the area's private sector increased only 1.3 percent in the year to May. Over the same period, the annual growth rates of loans to households and nonfinancial businesses increased 1.6 percent and 1.4 percent, respectively. That is low, way too low, even though these numbers are showing a string of steady monthly increases.

"Suicidal blindness"

But just as the Europe's central bankers were beginning to see patches of the blue summer skies, they are caught up in the headwinds of terrorist attacks that are negatively affecting an already fragile consumer and business sentiment.

The security threats hanging over Europe, and a wave of unfolding terrorist attacks, are another big difference in the economic environment where the Fed and the ECB have to deploy their policy instruments in the months ahead.

It is striking, for example, to see that, during its convention in Cleveland last week, the Republican Party fully acknowledged the threat of terrorist violence to the "civilized world," and decided to run its presidential campaign on the "law and order" platform, while Europe's diffident political elites show no similar resolve.

The current situation in France is a case in point. The public debate is a partisan blame game in the wake of the terrorist attack in Nice to such an extent that the philosopher Alain Finkielkraut is denouncing the "suicidal blindness of our elites," and their failure to defend "our civilization" against "radical Islam."

That is an ominous discourse when we hear that there were only 112 police officers patrolling Nice – a beautiful city of one million people covering an area of 280 square miles -- at the time when the terrorist drove his truck, crushing and shooting people for nearly 2 kilometers.

The Cleveland conventioneers would probably call that a total breakdown of "law and order."

Germany has also experienced four increasingly serious terrorist attacks since the beginning of the year, culminating with the Munich massacre last Friday.

How can households and businesses drive an economy under such a permanent state of siege?

Ignoring the reality and suffering the failure of what the former President George W.H. Bush called "the vision thing" is a lethal combination. But the German Chancellor Angela Merkelis still apparently saying that whoever wants to talk to her about a political vision "should see a doctor."

Pray to ECB

So much for the leader who is expected to hold the EU together, and to find a way of dealing with the area's weak economy and more than 20 million people without jobs and incomes.

Have no doubt, though, the Europeans' reality check is coming around.

Closer to home, our high-flying naysayers of the U.S. economy had their own reality check of sorts last Friday, as the Dow peaked out at 18,571.30 before settling to a 0.29 percent gain on the day (with 22 advancers and 8 decliners) and a 6.58 percent return since the beginning of the year. Nobody says better: Eurostoxx50 is down 9.04 percent, Nikkei 225 is down 12.64 percent and the Shanghai Composite is down a whopping 19 percent.

Remarkably, that was the Dow showing off on the eve of a week when 194 of S&P 500 companies are scheduled to report their quarterly earnings.

Strong U.S. equity markets are no mean feat at a time of the sluggish European economies, stagnating economic activity in Japan and a growth in China stabilizing at a slower pace. Taken together, these economies represent 40 percent of the world output. They accounted for 76.5 percent of our trade deficit in the first five months of this year, and they will probably take an entire percentage point from the growth of our domestic demand by the end of 2016.

So, yes, you heard it right when the people meeting in Cleveland last week reminded us that our key trade partners were "eating our lunch" and "robbing us blind."

I just wonder whether it was out of "political correctness" that the GOP tenors omitted to give kudos to that independent agency of the U.S. Congress that runs our monetary policy. Yes, please be fair: With fiscal and structural policies virtually frozen, our business cycle has been driven for years solely by cheap and widely available loanable funds.

It is, therefore, unfortunate that instead of taking to task those responsible for fiscal and structural policies, the naysayers keep heaping insults and opprobrium on the Fed for its support to the U.S. economy. What do these people want? By asking the Fed to withdraw that support, do they want an instant collapse of the world's largest economy?

The ECB is coming in for the same kind of irrational criticism from Germany. And Germans really mean it: They are suing the ECB in their country's highest court and at The European Court of Justice.

The European central bankers are correctly ignoring these mean-spirited and misguided German attempts to undermine whatever is left of the common market, which gave Germany last year 45 percent of its trade surplus. At 8 percent of the GDP, the German trade surplus is one of the key destabilizing factors of the monetary union, and it stands out as by far the largest trade bounty in the industrialized world.

Investment thoughts

The Fed will do nothing next Wednesday. Don't blame them for keeping their head down in the months ahead. Experts are announcing one of the nastiest and most vicious election campaigns in U.S. history. Get a six-pack, pop some corn and enjoy the fight.

The ECB, by contrast, will have to step up its support to the euro area economy as terrorist activity continues to dent consumer and business confidence.

The French authorities are so concerned about their crucially important tourist industry that any media reports about terrorist threats are frowned upon.

Germans are sharing the same concern. Much before the last Friday's Munich attack, German media ran reports that travel agencies were dealing with increasingly anxious and reluctant customers. The news was also spreading that the national carrier, Lufthansa, had issued a profit warning as a result of the declining passenger traffic.

Complacency, incompetence and sterile elitist philosophizing have created problems that will take a long time to solve.

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