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Dr. Peter Morici: An Emergency Interest Rate Cut? and The Week Ahead: Forecasts for the Weeks of November 26 and December 3 (preliminary)
On Nov. 20, stock markets were lifted on speculation that Ben Bernanke will call an emergency meeting at the Federal Reserve to further cut interest rates. This would be a remarkable turnaround for Chairman Bernanke.
On October 31, the Fed cut the federal funds rate a quarter point to 4.50% but essentially said that it would not likely cut rates further. The Open Market Committee stated: The Committee judges that, after this action, the upside risks to inflation roughly balance the downside risks to growth.
Since that time, virtually all the economic news has been bad. Wall Street firms are taking mega write downs on subprime debt, the stock market has tanked, retail and housing sales are in the sink, commercial real estate values are falling, and industrial production is contracting.
It seems the Fed is under pressure every few weeks to change course on policy. After telling us the subprime crisis was under control, both Bernanke and Treasury Secretary Henry Paulson gave speeches on October 15 and 16, explaining why exceptional action would now be required to rework adjustable rate mortgages, reestablish mortgage markets, and ensure general liquidity for the conduct of business.
Which is it Ben: Are we in trouble or aren't we?
We are!
The economy is delicately walking along a precipice between much slower growth and a tough recession. If the housing adjustment turns into a rout, it will be too late for the Fed to cut interest rates enough to save the economy from a bad episode of stagflation -- rising unemployment caused by evaporating household wealth and oil driven inflation.
Yet, the Fed seems at sixes and sevens on all this for four reasons:
First, the Fed has failed to grasp how the damage in the subprime market to the balance sheets of Citigroup, Merrill Lynch and others have damaged fundamental confidence in Washington's economic management and undermined the resiliency of the U.S. economy.
We have been suffering a crisis of confidence for many weeks, and the Fed doesn't get it. If it did, the Fed would not have precluded further action in its October 31 statement.
Second, unlike the European Central Bank, Fed policymaking primarily focuses on short-term interest rates and not money supply management. In large measure, the U.S. dollar's international status as the reserve currency -- other central banks use dollar holdings to back up their currencies -- makes both the supply of U.S. money and its impact on inflation unstable and difficult to manage.
The practical problem is that money is liquidity, and important segments of the U.S. economy are suffering from a liquidity crisis.
Third, the Treasury and Fed have failed to come to terms with the impact of China on U.S. monetary policy. China's policy of undervaluing the yuan and buying massive amounts of dollars and securities, to keep down the prices of yuan and its exports on U.S. store shelves, has significantly unhinged U.S. short-term interest rates from U.S. mortgage and other long-term rates.
Fourth, the Treasury and Fed have failed to come to terms with the corrosive consequences on bond, mortgage and wider credit markets of self dealing at Standard and Poor's and other bond rating agencies. No one is going to buy many private U.S. securities as long as rating agencies are paid by Wall Street bankers who appear able to manipulate the process.
(continue)
On October 31, the Fed cut the federal funds rate a quarter point to 4.50% but essentially said that it would not likely cut rates further. The Open Market Committee stated: The Committee judges that, after this action, the upside risks to inflation roughly balance the downside risks to growth.
Since that time, virtually all the economic news has been bad. Wall Street firms are taking mega write downs on subprime debt, the stock market has tanked, retail and housing sales are in the sink, commercial real estate values are falling, and industrial production is contracting.
It seems the Fed is under pressure every few weeks to change course on policy. After telling us the subprime crisis was under control, both Bernanke and Treasury Secretary Henry Paulson gave speeches on October 15 and 16, explaining why exceptional action would now be required to rework adjustable rate mortgages, reestablish mortgage markets, and ensure general liquidity for the conduct of business.
Which is it Ben: Are we in trouble or aren't we?
We are!
The economy is delicately walking along a precipice between much slower growth and a tough recession. If the housing adjustment turns into a rout, it will be too late for the Fed to cut interest rates enough to save the economy from a bad episode of stagflation -- rising unemployment caused by evaporating household wealth and oil driven inflation.
Yet, the Fed seems at sixes and sevens on all this for four reasons:
First, the Fed has failed to grasp how the damage in the subprime market to the balance sheets of Citigroup, Merrill Lynch and others have damaged fundamental confidence in Washington's economic management and undermined the resiliency of the U.S. economy.
We have been suffering a crisis of confidence for many weeks, and the Fed doesn't get it. If it did, the Fed would not have precluded further action in its October 31 statement.
Second, unlike the European Central Bank, Fed policymaking primarily focuses on short-term interest rates and not money supply management. In large measure, the U.S. dollar's international status as the reserve currency -- other central banks use dollar holdings to back up their currencies -- makes both the supply of U.S. money and its impact on inflation unstable and difficult to manage.
The practical problem is that money is liquidity, and important segments of the U.S. economy are suffering from a liquidity crisis.
Third, the Treasury and Fed have failed to come to terms with the impact of China on U.S. monetary policy. China's policy of undervaluing the yuan and buying massive amounts of dollars and securities, to keep down the prices of yuan and its exports on U.S. store shelves, has significantly unhinged U.S. short-term interest rates from U.S. mortgage and other long-term rates.
Fourth, the Treasury and Fed have failed to come to terms with the corrosive consequences on bond, mortgage and wider credit markets of self dealing at Standard and Poor's and other bond rating agencies. No one is going to buy many private U.S. securities as long as rating agencies are paid by Wall Street bankers who appear able to manipulate the process.
(continue)
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