Or, “Japanese Economics Class”
Agent Greenspan has spent most of the week talking out of both sides of his mouth. For example: homeowners are in fine shape except for the risky mortgage products, speculative activity, and cashing out of equity. If you want to take a shot at deciphering Greenspeak for yourself, here’s what he actually said today. Currently, Greenspan appears to be telegraphing that there will be a continued rise in interest rates, because there is a continuing risk of inflation. This is of course assuming that the trend of foreign owners of American bonds depressing interest rates does not continue.
Some analysts think this is just awful news. Doesn’t Greenspan know about the lousy consumer confidence numbers? Isn’t he worried about the people who are overextended on mortgages and credit cards? Doesn’t he want to keep interest rates low to stimulate the economy? Has he not noticed the flat stock market? Doesn’t he know that the Administration expects the hurricane damage in the Gulf Coast to sharply impact the economy? Has the old man lost his freaking mind?
Oh yeah, and what does Japan have to do with this?
WARNING! Severe Oversimplification Follows! Modern economic theory says that lowering interest rates stimulates the economy: it makes it cheaper to borrow money, and therefore easier for companies to buy manufacturing equipment — to say nothing of making it easier for Joe and Jane Average to buy things like houses and appliances and cars on credit. Raising interest rates, however, stifles inflation — and with energy prices being what they are, who can blame Greenspan for thinking inflation is a bigger potential problem than slow economic growth.
For some years, Japan has had economic problems. A huge stock bubble in the 80s was followed by a colossal bust in the 90s, and the economy suffered. More accurately, the economy suffered despite slashing interest rates to very low levels, even to zero! If you believe that low interest rates stimulate the economy, you must now be saying something along the lines of “HUH?”
The Japanese economy, while not where it was in the 80s, is now recovering. However, mucking about with the interest rates did not bring this about. It took dealing with underlying problems, in Japan’s case banking/credit reform and consolidation.
It is my theory that beneath certain levels, low interest rates do not stimulate the economy. There are several factors which combine to this result: First, when rates are very low, there is no incentive for lenders to extend credit to individuals and companies. Since the available rate of return is so low, they would rather take the sure thing on government bonds. Housing lending has continued partly because there is a real asset involved, and partly because such loans can be sold to aggregators such as Fannie Mae.
Second, when interest rates are very low, corporate borrowers — who are supposed to be goaded into action by super low rates — are mindful that the Powers That Be feel the economy is lousy. It is a bad idea to incur debts and invest in infrastructure when the economy is lousy. What will the stockholders say? What cash they do have they will sit on until the moment is right. After all, if the economy is lousy, they may well need the cash cushion. As for loans, they will wait for some kind of signal that things are improving — an increase in interest rates, maybe — before calling for cash.
Finally, the third leg of the economic table, Joe and Jane Average do not experience added liquidity. While the banks are more than happy to lend them money for concrete things like houses and cars, the banks won’t lend them cash for things that have a lasting impact on the economy. They can’t get cash to start a business (or to help along their existing business) because it’s too risky — for the bank, that is.
So, Alan? You just keep raising that interest rate, mmkay?