My fears that the lack of a coordinated G7 response to worsening credit conditions and a tumbling dollar would push markets to a “riot point” appear to have been borne out by recent events, culminating in the sad demise of Bear Stearns.

To recap, the Fed’s panic rate cuts have been counterproductive in terms of restoring market stability, because they have triggered a flight of capital out of the dollar at a time when US financial institutions face severe funding difficulties. Other G7 central banks, led by the ECB, have contributed to the mistake by refusing to ease their own policies, thereby increasing pressure on the Fed and presenting dollar bears with an open goal.

Over the last 10 days the Fed has announced measures to provide an extraordinary $382 billion* of additional financial support – equivalent to 2.7% of annual GDP. Markets are also fully discounting a further 100 bp cut to 2.0% in the Fed funds rate target at tomorrow’s FOMC meeting.

The scale of this commitment should not be underestimated and there is little doubt that the Fed will take further action if required. The effects may, however, remain disappointing without a coordinated G7 effort to stabilise the dollar, involving policy rate cuts by the ECB and Bank of Japan and the Fed moving to the sidelines, at least temporarily.

_{* Breakdown as follows: increase in Term Auction Facility $40 billion, increase in conventional term repos $100 billion, new Term Securities Lending Facility $200 billion, increase in foreign exchange swaps with other central banks $12 billion, special facility provided to J P Morgan related to acquisition of Bear Stearns $30 billion.}