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Thursday, June 02, 2005

Credit Conundrum

Robert J. Samuelson writes in the Washington Post:

Now the Fed wants to preempt the perils of cheap credit, starting with old-fashioned inflation. The problem is that the Fed directly influences only the obscure federal funds rate, which isn't used by ordinary borrowers. It's risen to 3 percent and may go higher. But the more important rates are those on long-term bonds and mortgages -- and, contrary to expectations, they haven't risen. To take one example: Rates on 30-year fixed-rate mortgages averaged 5.8 percent in 2003 (down from 8 percent in 2000). In 2004, after the Fed began raising rates, they still averaged 5.8 percent. What are they now? Well, they're 5.7 percent. No one quite understands why. It was expected that, as the Fed squeezed the total supply of credit, all rates would rise. Theories abound to explain what's happened: The Chinese (and others) are buying U.S. Treasury bonds, keeping down long-term rates; a better inflation outlook causes lenders to accept much lower long-term rates (lenders don't want their money eroded by inflation -- thus, prospects for low inflation reduce rates); the economy is actually weaker than it seems; the Fed hasn't yet offset its oversupply of cheap credit. Who knows? Even Fed Chairman Alan Greenspan calls the low rates on bonds and mortgages a 'conundrum.' Whatever their cause, they pose twin dangers. One is that more loans may turn out to be stinkers. Borrowers may miss payments or default. The second is that cheap credit is pushing some prices to speculative (that is, unrealistic) levels. 'Bubbles,' as we've learned, do ultimately pop.
He gives several examples of bubbles we seem to be expiriencing, but his final thought is probably the most important:
The U.S. economy is doing well. The withdrawal of cheap credit would be less worrisome if the rest of the world were doing as well. Any weakness would be offset by higher demand for U.S. exports. But much of the world is struggling. If something goes wrong in the United States, it could spread globally. Everything is interconnected. Hedge funds own mortgages, junk bonds and emerging-market bonds. Losses in one market can cause losses in others. Of course, that's normal. But will the normal trigger something more threatening? Cheap credit, once a blessing, could become a curse.
I am not enough of a financial analyst to even guess at the cause of continuing cheap credit or what the eventual results will be. The weakness of the world economy outside of the U.S. is very troubling though.

2 Comments:

Blogger The probligo said...

"If something goes wrong in the United States, it could spread globally. Everything is interconnected."

Remember the posts and the comments I was making, what, eight months back?

Here - http://probligo.blogspot.com/2004/10/colin-james-in-nz-herald-colin-james.html

and here -
http://probligo.blogspot.com/2004/10/econ-101-just-on-offchance-that-anon.html

and again here -
http://probligo.blogspot.com/2005/03/new-economic-miracle.html

The biggest threat of all is the prospect that the Chinese lose confidence in the US economy.

Unless the US administration does take concrete steps to remedy both internal and external deficits, then the risks as perceived by the Chinese WILL become too great.

When that does happen (not if at the moment) the impact could be as great as the US LOSING WW3.

The other certainty is that the US seems to survive not by good management or design, but by successive happy accidents.

Most recent of these? The problems the EU is having...

6/02/2005 08:55:00 PM  
Blogger Cubicle said...

"The other certainty is that the US seems to survive not by good management or design, but by successive happy accidents.

Most recent of these? The problems the EU is having..."

You cite the problems they EU was having as a "happy accident", but in reality it is design of the overall socialist ecomony that is casuing their problems.

6/07/2005 03:18:00 PM  

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