Central Bankers On Guard Against Inflation Prospects

0 Comments | Insight on the News, Nov 24, 2003 | by Jamie Dettmer

Byline: Jamie Dettmer, INSIGHT

Central Bankers On Guard Against Inflation Prospects

The Bank of England has become the first central bank in Europe to start raising interest rates. Some economists believe that it won't be long before the Federal Reserve has to follow if, like its British counterpart, it fears the emergence of future inflation.

Britain's central bank came much closer in October to increasing the then-current interest rate of 3.5 percent than observers realized. According to the minutes of an October meeting, Bank of England governor Mervyn King used a casting vote to keep U.K. interest rates on hold after four of his colleagues opted for the quarter-point increase, added Nov. 6.

Four members of the committee maintained that improved economic conditions meant it was appropriate to reverse July's quarter-point cut. They contended that domestic demand had been stronger than expected and that borrowing had continued to rise, suggesting that inflation was likely to overshoot targets.

However, they were outvoted by the remaining five members of the committee, including King, who remains less certain about the inflation picture. The minutes noted the majority's view that "A premature rise in the rate might choke off the improvement in business conditions."

In the United States, deflation fears are subsiding and being replaced, as in Britain, with concern about the prospect of inflation. Like the Bank of England, the Federal Reserve will face a dilemma if growth continues as strongly as it has in recent weeks. During the last quarter of this year the United States may experience a 6 percent growth rate among the fastest since 1978.

Federal Reserve Chairman Alan Greenspan is as reluctant as his British counterpart to move too quickly in raising rates, fearing that by jumping the gun he inadvertently may choke off the recovery.

The Consequences of Devaluing the Dollar

Is it necessarily the case that a lower dollar will help the U.S. economy to continue on its road to recovery? In recent weeks the Bush administration has let it be known that it has bought into the argument that a low dollar will stimulate exports and create jobs.

In October on his trip to Asia, President George W. Bush pressured the Chinese in particular to stop keeping their currency low against the dollar. But open support for a devaluation of the dollar from the White House could have unintended consequences that would far outweigh the benefits for U.S. manufacturers and exporters, say some economists.

While the Japanese, Chinese and other Asian central banks are buying U.S. Treasury securities worth more than $300 billion every year to stop the dollar from falling against their own currencies, they are in the process also supporting the prices of U.S. shares and bonds. If the dollar continues on its fall, and abruptly drops even further because of an Asian sell-off of Treasury securities or a slower purchase of them by the Asians, these economists say, then the U.S. stock market likely would

suffer and the Asian economies slow and Europe could fall back into depression.

The pressure to revalue Asian currencies appears largely to be driven by panic over the decline in President Bush's lead in the opinion polls. But a hasty change in currency policy well could risk making matters worse rather than better. U.S. Treasury Secretary John Snow remains unconvinced privately by the argument that something has to be done about the Asian currencies, although he has been careful to avoid clashing with the White House.

Already U.S. growth has accelerated spectacularly since the early summer. The downside, of course, is that unemployment, budget deficits and trade imbalances are higher than they should be, although the consensus among economists is that as recovery continues those evils will lessen. Unfortunately recovery takes time and, as a presidential-campaign season looms, electoral calculations are foremost in the minds of the political men in the White House.

Consulting Fees Still Taint Corporate Audits

The cloud over the auditing profession in the United States continues to deepen 15 months after Congress pushed through legislation aimed at restoring investor confidence and untangling the profession's many conflicts of interest.

Some of the dark cloud is colored by pre-reform problems. Dennis Kozlowski, the former boss of Tyco who has been on trial for defrauding his old company, attempted in court to push responsibility onto Tyco's auditor,

PricewaterhouseCoopers. Ernst & Young and KPMG continue to suffer embarrassment over their dubious past auditing of NextCard and Xerox.

But it also is not clear that the reforms passed by Congress are having much effect. Those reforms included banning auditors from providing certain consulting services for audit clients and changing the senior partner in charge of each audit each year.

The Big Four auditors still are able to provide many extras to audit clients and are getting around many of the rules by describing their extra work as tax planning or on-off projects. In short, lucrative consulting fees still can taint the auditing.