Inflation slowed dramatically in Canada, with most of the deceleration credited to falling car prices and less upward pressure from gasoline prices.

Canada’s Consumer Price Index (CPI) increased by 1.8% in the 12-month period from February 2007 to February 2008, the slowest rate of growth in six months, Statistics Canada reported yesterday (Tuesday). It’s also a dramatic turn from the 12-month increase of 2.2% reported in January.

Excluding gasoline prices, CPI rose 1.1%, the smallest increase since March 2004.

Inflation is below the Bank of Canada’s 2% target, meaning the Bank of Canada has room to lower interest rates at its next meeting on April 22.

But even with inflation in check, Canada’s economy is facing a potential slowdown in the face of a possible U.S. recession. Already this month, the bank lowered its benchmark rate 50 points to 3.5%.

“Inflation is under control and that’s good news,” Stefane Marion, an economist with National Bank Financial in Montreal, told Bloomberg. “Inflation is not an impediment to rate cuts in Canada, contrary to other countries where central bankers might be more hesitant.”

Unlike most rate cut scenarios, Canada’s economy is operating above its production capacity and both core and total consumer price index (CPI) inflation are lower than projected in its Monetary Policy Report (MPR) in October.

In this case, the rate cut was primarily a precautionary move – putting up its economic dukes to fend off threats of [and reactions to] a possible U.S. recession.

“Financial market conditions have deteriorated since October, leading to a tightening of credit conditions in industrial countries. Given this, and a deeper, more prolonged decline in the U.S. residential housing sector, the 2008 outlook for the U.S. economy is now significantly weaker than at the time of the October MPR,” the bank said in January.

Domestic demand remains strong because of rising incomes and commodity prices, the bank said. But effects of a weaker U.S. economy will stunt Canada’s exports, and the bank projects that growth in 2008 will be weaker than it projected in October.

Canada’s Economic Challenges

However, consumer prices rose 0.4% between January and February, compared with a 0.2% decline in the previous month. The core index rose by 0.5% between January and February, following growth of 0.1% recorded in the previous period.

“For the Bank of Canada, what this suggests is the free ride of ever declining core inflation may be coming to an end,” Doug Porter, deputy chief economist at BMO Capital Markets, told Reuters. “But I would still say that Canada has got much less of an inflation problem than basically everywhere else in the world.”

In the Bank of Canada’s annual report, issued March 14, departing bank governor David Dodge outlined seven challenges facing the country and bank:

• The need for flexibility in the reallocation of economic resources in response to changing circumstances,
• Building stronger international monetary and financial order,
• Maintaining sustainable levels of public debt,
• Improving the efficiency and stability of the country’s financial system,
• Renewing outdated infrastructure in the most efficient and timely fashion,
• Fostering greater growth in productivity,
• Keeping inflation low.

The Bank of Canada also projected a first-quarter CPI of 1.7% and core inflation of 1.4%.

News and Related Story Links:

• Statistics Canada: Consumer Price Index: February 2008
• Bloomberg: Canada’s Annual Inflation Rate Falls to Six-Month Low
• Reuters: Canada February inflation eases on lower car prices
• Bank of Canada: Annual Report 2007

The streetTRACKS Gold Trust Exchange-Traded Fund (GLD), an ETF that Money Morning’s investment gurus have recommended several times, has overtaken The Netherlands to take over the No. 8 spot on the list of the world’s top holders of gold, ResourceInvestors.com reported on its web site yesterday (Thursday).

The GLD ETF now holds 627.9 metric tons of gold – 138 metric tons behind No. 7 Japan, according to statistics from The World Gold Council and the web site SeekingAlpha.com.

With the ongoing skid in the U.S. dollar, investors have been fleeing the greenback and investing in gold – sending the yellow metal soaring to price levels not seen in nearly three decades. As it gains investors, the GLD ETF has continued to add to its gold holdings, according to the web site. At the same time, central banks – including that of The Netherlands – have been selling their gold reserves. And that’s elevated the ETF on the list of global gold holders [See Chart I].

Many analysts expect these trends – the decline in the greenback and central bank sales of gold reserves – to continue, meaning that the streetTRACKS Gold Trust will continue to move up the list. SeekingAlpha Analyst Tim Iacono predicts the ETF will pass by Japan’s central bank in roughly five months.
"Based on the current rate of growth … it will be only about five more months before the last major Asian central bank with a pitiful percent of reserves held as gold bullion is surpassed by the gold ETF," Iacono said. "The combination of recent sales by the Dutch and the steady creation of GLD shares lately … made this one all too easy to call."

Money Morning Investment Director Keith Fitz-Gerald predicts that with U.S. inflation creeping steadily higher, gold will likely touch $1,000 later in 2008, after experiencing a slight decline early in the year.

[Editor's Note: For our latest investment-research report on gold - part of Money Morning's ongoing "Outlook 2008" series that's previewing the top investments for the New Year - please click here. For our new investment report detailing ways to profit from the declining dollar, please click here. Both reports are free of charge].

Chart I: GLOBAL GOLD HOLDINGS

Sources: World Gold Council, SeekingAlpha.com, Money Morning.

News and Related Story Links:

• Money Morning Special Investment Report:
  Outlook 2008: Gold Investments Will Continue to Glitter in the New Year.

• ResourceInvestor.com:
  GLD Knocks off Another on World Gold Holdings List.

• Wikipedia:
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• Money Morning Special Investment Report:
  Nine Ways to Profit From the Diving Dollar.

Seeking to loosen global credit markets, the European Central Bank (ECB) pumped $501.5 billion into banks yesterday (Tuesday), adding liquidity and easing the cost of lending.

The rate for two-week loans dropped 50 basis points to 4.45%. That rate had spiked to 5.28% in the past two weeks, as banks froze cash anticipating a continued credit squeeze until the end of the year, the International Herald Tribune reported. Rates for one- and three-month loans also dropped.

"These are strong-arm tactics intended to show the market they’re seriously committed to breaking the deadlock," Marc Ostwald, a fixed-income strategist at Insinger de Beaufort Holdings SA in London, told Bloomberg News. "The ECB is helping to bankroll banks out of a problem that they themselves created."

The cash injection marks the second time in two weeks that central banks intervened to save lenders from the continued credit fallout. Last week, U.S. Federal Reserve Chairman Ben S. Bernanke cut the Fed’s key interest rate 25 basis points to 4.25% – the third rate cut in four months. The Fed followed up yesterday (Tuesday) with stricter rules to stop subprime mortgage lenders from doling out loans to unqualified borrowers.

More pertinent to Europe’s economy, the ECB’s liquidity boost comes on the heels of a massive $10 billion write-down last week from UBS AG (UBS), Europe’s fourth-largest bank.

Also last week, Forbes reported predictions that several other European banks will be facing write-downs: $4 billion for Deutsche Bank (DB), $3.2 billion for Societe Generale (SCGLY), $1.7 billion for Credit Argicole (CRARF), and a $1.4 billion write-down for Credit Suisse (CS).

And two weeks ago, Royal Bank of Scotland Group PLC (RBS), the U.K.’s second-biggest bank, announced it would write-down $3 billion.

If banks instill smarter lending habits and use this $500 billion wisely – and that’s a big if, considering what happened this year – it will help to stabilize their balance sheets and regain the trust of stockholders and the ECB.

News and Related Stories:

• International Herald Tribune:
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• Bloomberg:
  Money Market Rates Tumble; Central Banks Inject Funds.

• CNNMoney:
  Fed tightens up lending rules.

• Money Morning:
  Bad Day in Banking: UBS Offsets $10 Billion in Write-Downs With Sale of $11.5 Billion in Shares to Singapore.

Four leading members of the Bush administration’s economic team, including Ed Lazear, chairman of the Council of Economic Advisors, U.S. Commerce Secretary Carlos Gutierrez, Al Hubbard, director of the National Economic Council, and Jim Nussle, director of the Office of Management and Budget, convened on a CNBC TV panel last week and confidently predicted that the U.S. economy would avoid a recession.

As they uttered their platitudes, we learned that housing sales plunged again – with national inventories of unsold homes hitting a new record high – and that Merrill Lynch & Co. Inc. (MER) had disclosed nearly $8 billion in write-offs. Set against this backdrop of deteriorating economic news, it would have been more honest – and perhaps more effective – if the administration team came on stage in clown makeup and oversized shoes.

The Weak Dollar Dance

The group’s most entertaining routine could be described as the "falling dollar hot potato."  It is a testament to the professionalism of CNBC host Dylan Ratigan that he was able to suppress howls of laughter while the economists scrambled to avoid any discussion of the dollar by claiming that only the president and the secretary of the treasury were allowed to comment.

How can the leading economic policymakers in government refuse to discuss the value of our money, which is arguably the single most important part of our economic system?  Why is the subject taboo?  Perhaps they feel that anything they say will only inspire less confidence in the dollar?

In reality, the administration is pursuing a policy of benign neglect.

In addition to the dollar dance, the wacky economists also provided some laughs on a variety of other subjects. Regarding the California wildfires, the panel reassured us that the resilient U.S. economy would weather the storm, much as it did with Hurricane Katrina.  However, as state and federal officials promise unlimited funds to rebuild thousands of burned homes, they conveniently ignore the fact that we must put the tab on our national charge card.  The ability to postpone pain by borrowing from abroad is evidence of economic vulnerability, not economic resilience.  A truly resilient economy has ample domestic savings to cover these vicissitudes itself.  America has yet to pay the costs associated with a string of natural disasters, the bills for which will likely come due much sooner than anyone seems to realize.

The administration gang also told us that the American economy will benefit once China moves to an economy based on consumption, rather than savings (in other words, more like our economy), as that country would finally begin buying more of our products.

U.S. Creditor Concerns

Although it is reasonable to expect that China will inevitably start spending more, it is ridiculous to assume that this spending will benefit the United States. When the Chinese begin spending, they will simply snap up their own abundant production and send fewer goods to America.  As the Chinese reduce their savings to begin enjoying the fruits of their labor, American borrowers will lose access to their largest source of credit.  The two-pronged effect on the American economy will be substantial increases in both consumer prices and interest rates – hardly the benign outcome all the president’s men expect.

None of them seemed too concerned about the cost of funding the war in Iraq (already more costly than either Korea or Vietnam in inflation-adjusted terms), which on the day of this “summit” we learned is now projected to be almost $2 trillion.  Their lack of concern likely reflects their belief that Americans are not the ones picking up the tab.

But I’m sure there is a much different reaction among our foreign creditors, as they contemplate the prospect of “loaning” us that much more money – knowing that a declining dollar guarantees they will never be repaid in full.  Perhaps the thought of loaning us endless sums to cope with natural disasters at home and man-made ones abroad will shock foreigners to their collective senses, and prompt them to finally cut us off.

The Mounting Mortgage Debacle

On housing we were once again told the problems would be contained. Such upbeat pronouncements should be wearing thin in the face of mounting evidence to the contrary.  When will people begin to grasp that the trillions of dollars of mortgage loans financed by Wall Street will never be repaid in full and that the losses for lenders will be staggering? 

Homeowners have lenders over a barrel, and soon all will know it.  Once the government exempts forgiven mortgage debt from being treated as taxable income, defaults will become a national trend.

Under normal circumstances, lenders have all the power, as 20% down payments and an ample supply of qualified buyers makes foreclosure a real threat.  However, under current circumstances, that threat is completely empty.  Lenders cannot foreclose, as there are no buyers and no equity.  If homeowners choose not to pay, lenders really have no choice but to renegotiate the loans.

Once homeowners understand this, no one will make a mortgage payment until their loan is reduced to an amount more consistent with the actual value of their home.

While homeowners themselves will experience mere paper losses, the losses that lenders incur will be all too real.  However, even with less mortgage debt, homeowners will finally wake up to the fact that their home equity is gone.  Without that cushion, Americans will be much more like the Chinese of today – consuming a whole lot less, and hopefully saving a whole lot more.

Money Morning Guest Columnist Peter D. Schiff is president of Euro Pacific Capital Inc., a Darien, Conn.-based broker/dealer known for its foreign-market expertise. A well-known financial author and commentator, Schiff has a reputation for making calls that conflict with the conventional Wall Street wisdom – and being right. In mid-August, when analysts were touting beaten-down financial shares, Schiff said the stocks were “toxic,” were destined  “to get hit hard,” and advised investors to “stay away.” Investors who heeded that advice, and avoided such shares as Merrill Lynch, also avoided some stressful losses. Schiff’s first book,“Crash Proof: How to Profit from the Coming Economic Collapse,” was published by Wiley & Sons in February.

News and Related Story Links:

• Europac.net Book Review:
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• Video Clip:
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• Video Clip:
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• Money Morning Investment Report:
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• Money Morning Investment Analysis:
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• Money Morning Investment Analysis:
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• Money Morning Investment Report:
  
  Jim Rogers Warns of Fallout From Fed Cuts; Says to Seek Profits in Commodities, Asian Currencies.

• Money Morning Investment Analysis:
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• Money Morning News Analysis:
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• Money Morning Investment Report:
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• Wikipedia:
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• Business Week:
  Bush’s Worrisome Weak-Dollar Policy – Budget and Trade Deficits Invite a Dollar Crash, Followed by Recession.

• National Review Online (NRO):
  Bruce Bartlett Commentary: Bush and the Buck – A Weak-Dollar Policy is a Mistake.

• NPR:
  
  Politics of the Weak Dollar.

• Money Morning News:
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Some days you’re the bug and some days you’re the windshield.

Yesterday (Tuesday), there were a whole lot of bugs in the guise of the short-sellers who got squashed on Ben Bernanke’s windshield; they covered their positions at any cost and then limped into the hills to hide.

Trading volume was huge and the rise of the major indices meteoric. But what’s not clear is whether this stunning rally is strong enough to go the full nine innings.

History suggests that Fed-related ‘market bottoms,’ or low points, can serve as the launching pads for powerful rallies. So I won’t rule out the possibility that yesterday’s big stock-price rally – which included the biggest one-day gain by the Dow Jones Industrial Average in nearly five years – will turn into a high-scoring affair.

[For a full news report on yesterday’s Federal Reserve decision, and the surge in stock prices that resulted, click here. For some investment ideas from Martin Hutchinson, our director of global investing research, based on the Fed’s decision yesterday, please click here.]

Even so, I find that I’ve got a bit of a cynical feeling about yesterday’s market action, if for no other reason than similar rate cuts did essentially nothing for stocks in 2001 and 2002 under very similar “bubble-like” conditions.

Nor did big rate cuts help Japan much, either, not even when that country’s central bank slashed interest rates all the way back – to 1%  – and that country fell into a 15-year recession. Talk about a shutout!

Therefore, the question in my mind – and the one that I think most people need to be asking themselves over the next couple of days – is this: What does the Fed know about how bad things really are that Bernanke had to go to the central bank’s bullpen, and pull out a rate reduction of a full half a percentage point?

In other words, are we dealing with a bona fide slugger, a true legend-in-the-making, like “Hammerin’ Hank” Aaron? Or is our Fed chairman more of a likable, good-natured duffer like Bob Uecker?

Either way, I think Team Bernanke brought in the heavy artillery much earlier than seemed necessary, and perhaps wasted a shot in the process.

Here is the view from the bleachers, at least as I see it:

• One: The Fed has spent the past month injecting tens of billions of dollars in liquidity into the U.S. financial system just to help bail out a group of folks who could be the poster boys of subprime-mortgage mismanagement. There should already be a copious amount of liquidity out in the financial system, without having to also lower interest rates. Assuming this is true, there shouldn’t have been the need for such a dramatic cut this early in the game. That’s ‘Strike One.’
• Two: The job rolls are falling, gold is rising and oil traded at more than $80 a barrel last week – the first time it eclipsed that price level. Other commodities are up as much as 80% in the last five months. These are classic signs of inflation, and they aren’t going away. Against such inflationary pressures, a hefty rate cut is more like a Rip Sewell ‘Eephus’ pitch, than a Roger Clemens fastball. The rate reduction doesn’t help us much, and with the wrong timing, it may get ‘taken downtown’ for an inflation inducing grand-slammer. That’s ‘Strike Two.’
• Three: The dollar has fallen below the capital markets ‘Mendoza Line,’ and the greenback continued to fall today – even in the midst of the biggest single day U.S. stocks have enjoyed since October 2002. This makes the dollar an even-less appealing holding for overseas investors, and it may well have opened the door for our biggest debt-holders (China, Japan and Korea), to start dumping dollars, which would be catastrophic for this country’s economy on a variety of fronts. That’s … Juuuusssst a bit outside … ‘Ball One.’

What? No strike? Didn’t the ump “ring us up” with a called third strike?

Nope. As bad as a weaker dollar is in global terms, it’s actually great for investors who own what I like to call the “Global Titans.” You’ve heard me talk about these before. These are globally diversified companies, and most of them have nice businesses in Asia, and in China in particular, where the economy is growing at a 12% annual clip. They’re great stocks to hold anytime, but during periods of severe uncertainty (especially uncertainty caused by interest-rate stress), there’s almost nothing better to own on the equity side of the ledger.

An easy way to get in the game is to pick up the SPDR DJ Global Titans (DGT), which is traded both in Frankfurt and New York. It’s a quick way to snap up dividends and draw support from the world’s biggest brands at the same time.

All in all, I think yesterday’s rally was a gift.

On one hand, the Fed got its way. On the other, it highlighted just how fragile the U.S. economy is at a time when the global markets are actually gathering steam.

Batter up!

Related News and Story Links:

• Money Morning News: Bellwether Blue Chip Stocks Record Best Week Since April.
• Wikipedia: Rip Sewell and the Eephus Pitch.
• Baseballreference.com: Roger Clemens.
• MSNBC.COM: Wall Street Delighted by Aggressive Rate Cut.
• Wikipedia: The Mendoza Line.
• Wikipedia: Bob Uecker.
• Baseballreference.com: Bob Uecker.
• Baseballreference.com: Hank Aaron.

While central banks in the United States and Europe did their best to infuse their respective economies with liquidity, central banks in China and Japan were doing just the opposite. The People’s bank of China last week sold $20 billion worth of three year treasury bills hoping to siphon off excess funds and cool off its economy.

Meanwhile the credit crunch that has taken hold in the United States and Europe introduced the largest injection of funds since early August into the banking system. The Federal Reserve injected $31.25 billion of liquidity, the largest single-day amount since August 10, while the European Central Bank (ECB) lent banks an extra $58 billion and The Fed’s decision to add liquidity was prompted by the need to keep the primary funds rate at its target level of 5.25%.

China, by contrast, raised the level of funds banks are required to set aside for the seventh time this year. Japan, which, after a decade of inflation has the lowest interest rates in the world, is also moved its rates higher, from 0.43% to the target 0.5%.

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The Bank of Canada announced Wednesday that it will keep its target for its overnight lending rate at 4.5%, and indicated that previous hints at a rate increase are economically rational, but premature.

The economy of our northern neighbor is growing at a faster clip than expected. Its total and core CPI inflation for July clocked in at 2.2% and 2.3%, respectively, higher than its target of 2%. Its dollar has been gaining steadily on its U.S. counterpart, hitting a 30-year high at 96 cents to the dollar – or nearly par.

Domestic demand is “robust,” pushed by a growing labor market and — to surprise of some of U.S. investors — higher-than-expected increases in home sales and housing prices, the Bank of Canada said in a statement.

Canada’s central bank said “the pace of economic growth in the first half of this year was above the Bank’s expectations. It now appears that the Canadian economy is operating further above its production potential than was estimated in July.”

Virtually all indicators point to raising rates to keep inflation within reach of its target.

The exception: The United States, because of its credit-market and housing-sector woes. The U.S. central bank’s policymaking Federal Open Market Committee is scheduled to meet on Sept. 18, where most observers expect that a discussion of reducing short-term interest rates will be on the table.

So, in effect, Canada’s rate hold is as close to a rate cut as you can get because, again, all economic signs indicate that the Bank of Canada would have increased rates if looming credit concerns to its south did not exist.

“Against this background, the Bank judges that the current level of the target for the overnight rate is appropriate. However, there are significant upside and downside risks to the outlook for inflation. On the upside, there is a possibility that household demand in Canada could be stronger than anticipated, while on the downside the ongoing adjustment in the U.S. housing sector could be more severe and spill over to the U.S. economy more broadly,” the Bank of Canada’s statement said.

Canada is one of several countries that are holding the line on interest rates, waiting to see what the U.S. central bank does for its next move. The Philippines and Japan are others. The European Central Bank and Bank of England are also expected to announce they will keep their rates as early as this week.

Other countries have been slashing rates: Australia, Chile, China, Hungary, Norway, South Africa and South Korea have recently cut rates to ease borrowing costs. To be clear, all have different reasons, but a possible U.S. recession is near the top of each of their lists because they rely on this country to buy their exports.

But in hindsight, their decisions to keep, cut or raise rates now won’t be as important as what they do with their rates after the U.S. Fed decides what to do. And the Bank of Canada knows this, as the “full update” of the Bank’s outlook of growth and inflation and won’t be released until Oct. 18.

That date is important for several reasons: It is two days after the Bank of Canada’ next decision to raise or keep rates. And it’s a full month after the U.S. Fed’s next scheduled meeting (though it can act between meetings), which gives the Canadian central bank time to measure and act.

Germany is on its way to a surplus for the first time in 18 years, the Financial Times reported – a bit of a surprise given that country’s exposure to the U.S. subprime mortgage mess.

In fact, two German lenders had to be rescued after investments linked to the U.S. subprime market collapsed.

Despite the financial hits taken by its banks, Germany still managed a budget surplus in the first half of the year, exceeding the expectations of the government, as well as the expectations of the most optimistic of economists. It managed a $1.6 billion surplus, only the second midyear surplus Germany has seen in the past 20 years. By this same point last year, the country was running $31 billion in the red, Germany’s statistics bureau said.

The increased revenue appears to be the result of a 29.8% increase in wages, as well as an 11.9% jump in corporate-tax revenue. Over the past few years, Germany has benefited from lower unemployment and rising corporate revenue and wages. Still, the rapidity at which Germany has improved upon its fiscal efficiency, which has been bleak as of late (Germany breached the European Union’s fiscal rules every year from 2002-2005), has been astonishing, experts say. 

Such good news couldn’t have come at a better time for the country.  Germany is one of the European countries that has been most affected by U.S. subprime mortgage defaults. In the past three weeks, German banks IKB Deutsche Industriebank AG and Sachsen LB had to be rescued because of their exposure to credit markets.

Sachsen fell into a liquidity crisis of its own when it attempted to roll over some commercial paper – typically a very routine financing process – but found that its usual cast of lenders had evaporated. The bank had a large exposure to U.S. asset backed securities through an Irish affiliate, Ormond Quay. IKB is a small commercial lender that found itself in a similar predicament, when it was no longer able to refinance its commercial paper program – meaning it could no longer function as a financial institution. As a result, Germany’s federal development bank, KfW, issued close $11 billion worth of relief.  

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The problem in Germany seems to be an overabundance of banking institutions and an unwillingness to let banks that employ faulty practices sink. An overpopulated – and therefore lackluster – home market has forced small institutions like Sachsen LB to make up for the lagging profits with aggressive trading strategies and risky overseas-market forays for profit. Meanwhile, the German government’s refusal to turn its bank on poorly managed – or inadequately financed or shoddily run – institutions doesn’t allow for a culling of the herd. 

Right now, some German factions are proving to be more concerned than others. West LB CEO Alexander Stuhlmann told journalists at a recent banking event that: “We sense reluctance on the part of foreign partners to extend credit to German banks,” adding, “if we have a banking crisis in Germany with other countries cutting us off, then other banks will also face difficulties.”

A poll administered by the Zew Center for European Economic Research justified Stuhlmann’s concern. It found that investor confidence has fallen to an eight-month low.

Still, Germany’s finance minister Peer Steinbruek seems to think that such fears are unfounded, saying: “We have no reason to believe that the consequences of the crisis that has been caused by the U.S. mortgage sector will spill over to Germany and the European Union. As far as we can see, there is no spillover effect into the real economy.” 

Other German ministers and economic institutes, including the Berlin-based DIW, have likewise concluded that there are no indications that German production, hiring, or spending has been affected.

Regardless of their point of view, the latest news of a surplus bodes well for that country, especially because the German economy typically picks up momentum in the second half of the year. Christmas bonuses and seasonal sales usually mean more income and value-added tax (VAT) revenue in the second part of the year. Fiscal performance has improved in the back half of the year in Germany for the past three years. 

Should Germany, a country with a poor fiscal record, a contingent of bloated financial institutions overly reliant on risky foreign assets, and a government all too eager to rescue said institutions when they get into trouble, produce a surplus during this devastating credit crunch, then there’s hope for us all yet.

Related Articles:

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• Money Morning Report:
  Central Banks Inject Money Into System.
• Money Morning Report:
  Europeans Won’t Euthanize Corporate Stupidity.
• Money Morning Report:
  Investing With Caution During a Global Financial Crisis.
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Central banks in Europe, Asia and the U.S. injected more cash into the global financial markets yesterday (Tuesday), in a continued campaign to allay investor fears, The Associated Press reported.

The European Central Bank placed $370.6 billion in its normal weekly refinancing, adding to emergency maneuvers it’s undertaken over the past few weeks. The U.S. Federal Reserve followed up with another $3.75 billion, the newest round of moves that have now exceeded $100 billion since last week. U.S. Treasury Secretary Henry Paulson said the United States will successfully navigate the credit crunch caused by the subprime meltdown.

The Bank of Japan yesterday opted to lend another $7.01 billion after an injection of $8.71 billion on Monday. The Reserve Bank of Australia lent banks $3.64 billion, while the Bank of England lent $622.3 billion – its first emergency loan since the subprime credit crisis began. [For a report from our global financial expert Martin Hutchinson on how to navigate the credit crisis – avoiding the fallout and perhaps even finding ways to profit – click here].

The credit crunch started with rising defaults in U.S. subprime mortgages – home loans made to homebuyers with generally poor credit histories. But the crisis has spread so quickly because banks and hedge funds all over the world invested in this high-risk debt to a much-greater degree than anyone believed. In many cases, the banks really had no business making these investments – especially those in Germany and France.

The effects have been felt in Europe, especially in Germany, where state-owned wholesale bank Landesbank Sachsen has said it would need a $23.3 billion credit line bailout, thanks to its exposure to the U.S. subprime credit business.

That exposure – as well as the problems at IKB Deutsche Industriebank AG (FRA: IKB), which relied on several banks to protect it from its $11 billion subprime exposure, has really rattled investors, who almost feel as if they don’t know where the next lightning bolt will strike.

Then, at a European banking symposium Monday, Alexander Stuhlmann, the chief executive of German state-owned bank, WestLB AG, said there could be a major financial crisis in Europe’s No. 1 economy if credit issues persist. Stuhlmann warned that foreign financial institutions were increasingly reluctant to extend credit to financial institutions in Germany, which could cause major problems.

“We sense reluctance on the part of foreign partners to extend credit to German banks," Stuhlmann told journalists during an impromptu chat on the sidelines of the banking event, wire services reported. “If we have a banking crisis in Germany with other countries cutting us off, then other banks will also face difficulties.”

German Finance Minister Peer Steinbrueck was more optimistic, denying there were any signs of such fallout, and adding that he believed “those involved have the situation in hand.”

Interestingly, a poll of German sentiment among institutional investors dropped to its lowest level in a year, according to the ZEW Institute.
 

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