Montreal, Canada

The odds that central banks in the major market economies will get their timing exactly right as they withdraw mountains of excess liquidity from the financial system remains low. Both the Federal Reserve and The European Central Bank (ECB) threaten a budding economic recovery by undoing unorthodox monetary and financial intermediation assistance programs at a time when several key markets remain frail and still dependent on government support.

In the United States, mortgage-financing is still on government life-support and all indications continue to point to a weak housing recovery amid high unemployment, declining real wages and income and the challenges securing mortgage credit.

In Europe, Greece's fiscal woes and the likelihood of weaker peripheral EU countries suffering a similar outcome will put pressure on the ECB to keep interest rates low. Housing markets in Ireland and Spain remain extremely weak and higher rates are the last thing these countries need now.

The Institute of International Finance's Market Monitoring Group cautioned that there would be considerable repercussions for mortgage rates and home prices once global central banks siphoned fiscal stimulus measures enacted during the latter stages of the credit crisis. The group represents the largest contingent of financial institutions co-chaired by the former governor of the Banque de France, Jacques de Larosiére and David Dodge, former governor of The Bank of Canada. It also includes executives from HSBC, Citigroup and Deutsche Bank AG.

The group's thrust argument is that there would be a "significant impact on banks' capacity to lend from the end of support programs and warned that fiscal consolidation and regulatory uncertainty were also adding to concern over the future supply of credit."

The Fed talks a tough game on inflation but its long-term track record defending the dollar is pathetic. Bernanke, an ardent student of the Great Depression and U.S. monetary and fiscal policy during that period, is likely to wildly overshoot credit growth or the expansion of the money-supply in order to boost inflation, which is not a bad thing at this stage of the economic cycle. The United States starves for inflation.

Commercial and industrial bank credit in the United States remains in negative territory over the last 3, 6 and 12 months and won't turn positive until banks start lending again; it's only a matter of time until that happens. Banks won't sit on a pile of Treasury bonds forever, feasting on the yield spread between short-term and long-term rates. That game, coined "free money," is drawing to an end in 2010.

At some point long-term rates will rise and the Fed will start tightening at the short end. That will force banks to unload longer-dated Treasury paper and do something else with their capital – lend. At that point, we'll have a serious inflation problem because the Fed will be too late to drain excess banking reserves – despite promising to avoid that outcome in recent Fed minutes and Congressional testimony.

The Feds talk a tough game. But the reality of the situation is still dire. Deflation continues to grip real wages, housing and financial assets since late 2008. Credit is still impaired and the securitization market is barely growing. Unless there's a massive spending boom courtesy of big business, it's almost a given that we'll enter the gates of a double-dip recession in 2011.