This is my column this week from the Arizona Republic (permanent link):
Fed trades a sharp pain, quick recovery for extended convalescence
As I write this the Federal Reserve Bank just cut its federal funds rate and also its discount rate, both by half-a-percent. The Fed doesn’t control mortgage interest rates, but, for good or ill, it does have a powerful influence on every aspect of the American economy. These rate cuts send a very strong signal that the central bank intends to stave off any impending liquidity crisis.
So what just happened? We are almost certainly about to enter a time of financial distress — if not a recession then something very close to it. The nation’s central bankers have opted for a longer period of lower-level pain over a brief but very intense agony. It’s as if your broken leg were healing badly, and, rather than re-breaking the bone, your doctor elected to correct the defect with braces, weights and painful exercises.
Which would you choose if you had a choice — a quick, intense pain or a long, drawn-out recovery? It doesn’t matter. You don’t have a choice.
Starting with the dot.com collapse and accelerating with 9/11, the Fed has pumped the American economy full of money. To the extent that that money was wisely invested in increased productivity, it was well used. To the extent it was wasted, it will have to be redeemed — like a bad check hanging over your credit rating.
This is the financial distress we have to look forward to. Given a choice, you might swallow hard and live through that short spasm of agony. Instead, the Fed’s action this week may turn a short-term crisis into a long-term syndrome. Rather than re-breaking the bone, living through the healing and getting back to work, we could be spending the next few years on financial crutches.
On the plus side of the ledger, mortgage rates should go down in the immediate future. It remains to be seen if this will bring buyers out, but this may turn out to be an opportune time to refinance mortgages or home-equity lines of credit, perhaps converting all your debt to a long-term fixed-rate mortgage.
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Derek Burress says:
The good side:
The Federal Reserve cuts discount points = Banks able to borrow more money.
Banks now able to borrow more money = lower interest rates to attract borrowers.
More borrowers = More qualified home buyers.
More Qualified home buyers = More homes sold.
More homes sold = More Real Estate Agents make.
The bad side:
The Federal Reserve cuts discount points = Banks able to borrow more money.
Banks now able to borrow more money = lower interest rates to attract borrowers.
Lower interest rates to attract more borrowers = less interest rate paid to depositers in banks.
September 21, 2007 — 9:13 am
David G says:
… and don’t forget the impact on the dollar. A major impact of this rate cut will be the continued weakening of our currency. On a global basis, we’re going to be pretty poor by the time we pull out of this (now protracted) local funk. Here’s a scary anecdote; I hear that a few Canadian companies are actually considering outsourcing their call center operations to (low cost???) US operations. For the past decade it’s been the other way around.
September 21, 2007 — 9:32 am
Greg Swann says:
> I hear that a few Canadian companies are actually considering outsourcing their call center operations to (low cost???) US operations.
Never happen. Canadians can read. Americans can’t. My father-in-law’s personal domain was registered in New Zealand, I don’t know why. I needed to move his domain to our server, so I had to change the DNS servers, which meant proving identity. Time zones introduced delays, but the people were first rate, able to read a simple support ticket from start to end without getting lost. I can see moving intellectual work to Bangalore but not to Buffalo.
September 21, 2007 — 9:40 am
Derek Burress says:
My domain – I guess is registered here – at least it’s in my name but the server is in Brisbane, Australia.
David: I was watching some guy named Cramer on MSNBC last night talk about the value of the dollar and that of gold. Never really thought about money being pumped in the economy is going to weakening the value of the dollar but now that I think of it, you’re right.
Call centers: A close friend of mine worked for three of them. I am going to jump the gun here and suggest that call centers are going to increase their rates as they cannot retain employees very well. Just look in your college newspapers in the “help wanted” section… the pay has already jumped like $1.50 per hour since last year for part-timers to handle incoming calls.
September 21, 2007 — 9:50 am
Robert Kerr says:
I don’t often find myself nodding in agreement while reading your posts; this time was the exception.
Well done. Good analysis and analogy.
I wish more people would look beyond their own pockets to try to see the big picture.
The Fed seems to be choosing the same path Japan took in the early 1990s – don’t fix the problems, just pump more liquidity into the system.
That strategy ended badly for the Japanese and I don’t see any reason why it should end any differently for the US.
September 21, 2007 — 11:06 am
Greg Swann says:
Chicago School, via the Austrians. Recessions start when the central bank stops inflating the currency and end when productivity rises to redeem the mal-investment. By not quite stopping the currency inflation, the economy will have a hard time catching up and healing. On the plus side, the price of gold argues that the money supply has increased enormously, but this increase is not reflected in many other categories of prices. It’s possible that the computer revolution is redeeming all that bad investment far faster than we have any right to expect.
September 21, 2007 — 11:20 am
Robert Kerr says:
On the plus side, the price of gold argues that the money supply has increased enormously, but this increase is not reflected in many other categories of prices.
re: “not reflected”
Not yet reflected … because the Chinese and Saudis – our two largest import partners, by far – pegged their currencies to ours for many years.
The Chinese broke away two years ago, but still keep the yuan close (for now), the Saudis broke this week and are reportedly busy selling dollars.
If the Chinese and Saudis switch to the euro – and why wouldn’t they given the decimation of the dollar by the Fed? – we’ll experience significant inflation, very quickly.
September 21, 2007 — 11:52 am
Eddie D says:
This will bring long term rates higher in the long run. Look at the dollar, in the toilet. The Canadian dollar is now worth more. Rampant inflation is here and higher yields will be soon enough.
Ben B just took the housing market off life support.
September 21, 2007 — 1:25 pm
Chris says:
Time to convert capital to euro’s and gold I think.
September 22, 2007 — 1:00 pm