Monday, September 18, 2006

Pushing on a rope

Fed expected to hold interest rates

At what point does it not matter what the Federal reserve does with interest rates? While they can choke an economy easily by raising rates, when do they have trouble stimulating the economy? What I'm referring to is the US economy's need for capitol inflows to sustain our economy. What happens if the fed pauses on interest rates again?:


  1. We can expect the dollar to weaken versus foreign currencies.

  2. Foreign capital inflows to the USA will slow

  3. Inflation risk edges up

At this moment I believe the risk of deflation is greater than inflation, so I'm going to make only a few comments on inflation. Due to the eventual devaluing of the US dollar that is going to occur, imported goods will get more expensive and thus we are going to have consumer retail inflation due to that. But I still think deflation is a greater risk due to the abruptness with which credit can be cut off.


This brings us to point #2, the reduction of foreign capital that feeds our insatiable need for cheap imports. Inflation in the low interest/fast growth world was avoided by the integration of the world economy. Each country has found its niche to fulfill in the global supply chain. The problem is the US has done a much better job putting off paying the bills than is healthy. Like an alcoholic college kid, eventually its time to sober up and pay the bar tab.


We currently borrow 2 billion dollars a day to feed our import habit. We've gone beyond being a casual user to credit junkies. And now we find out in July the Capital inflows were short (google capital inflow July and you'll find your favorite news service has the article).


So let's say the Fed drops rates yet foreign interests still cut back the capital inflows. That would lead to the USA printing money to keep the economy going. But as foreign buyers purchase most of the mortgage backed securities right now (MBS), its going to seize up the home buying market.


Thus, another reason why I wait. Oh, this scenario probably will happen by degrees. But someone explain to me why there are 984, 773 properties for sale on ziprealty.com (nationally) when during the summer selling season there were 2/3rds that number?


Anyone who thinks homes will land softly hasn't looked at the fundamental numbers. Shiller just noted that we now have more home inventory for sale than anytime since 1955. And this is with the economy still “going strong.”


During the Japanese recession, real interests rates were zero percent and they were stuck in a decade long deflationary recession. They were pulled out by the global economy. The US? We'll pull everyone else down. Is Asia and Europe ready to support the US? Their citizens will stop throwing money at us to borrow. So how will be pay for their exports?


I think the Fed's rate hold and soon to be future decreases will not do much to stimulate the economy. It will be like that sailor trying to move the boat by pushing on the rope.


Neil

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