Outlook: G7's band aid solution won't work

WHAT DO world leaders mean when they talk about "co-ordinated action" to deal with the crisis in the international economy? Financial markets would like to think it means a synchronised cut in interest rates across the G7 countries; certainly that is what is required to put a convincing floor under Western equities right now.

Unfortunately, it is already plain as a pikestaff that this is not going to happen, not in the immediate future at least. Politicians can presumably still hope to influence the level of interest rates, but they no longer determine them. And the central bankers who do are sticking religiously to their brief, which in most cases is to keep the lid on domestic inflation.

Thus Eddie George, Governor of the Bank of England, was unable to hold out any more than the hope that interest rates have peaked at this week's TUC conference. Hans Tietmeyer, his German counterpart, was more intransigent still. Monetary policy in euroland was just fine, he said, and there would be no cuts. So that appears to be that, for four of the G7 at least.

As for the remaining three, there's no chance of a cut in Canada while the currency remains so weak. And in Japan, rates are already as low as can be without getting into the cloud-cuckoo-land of having to pay the borrower for the privilege of lending to him.

In the end, of course, the only one that really matters is the US. But even here official thinking on policy has yet to shift significantly away from the old priority of controlling inflation to dealing with the new threat of deflation. If Alan Greenspan, chairman of the Federal Reserve, has changed his thinking, he was offering few clues to it in his Congressional testimony last night.

There are, of course, other things world leaders can do to counter the present threat to the international economy beyond cutting interest rates or introducing capital controls. Gordon Brown, the British Chancellor, has been full of them during his visit to Japan. Mr Greenspan was similarly on message during his testimony last night. They could, for instance, bolster the IMF with fresh funds. If Republican opposition in the US continues to frustrate this process, bilateral loans to crisis-torn regions might be possible. There is already talk of such action in the event of the crisis snowballing in Brazil. There are also alternative ways of adding liquidity to markets.

Regrettably, set against the battering ram of interest-rate policy, none of these solutions offer more than a band-aid approach to the problem. It is the job of central bankers to stand above often-exaggerated predictions of disaster and make a considered judgement on these matters, but over the last month, the odds on the emerging markets contagion spreading to the US economy do seem to have shortened significantly. Given the seriousness of the position, it would be unwise of the Fed to test the point.

As George Soros, the international speculator, neatly put it in his testimony earlier this week to the US House Committee on Banking and Financial Services: "Financial markets are peculiar in this respect: they resent any kind of government interference, but they hold a belief that if conditions get rough, the authorities will step in." For the time being that presumption is proving a long way from the truth.