This is more evidence for a theory that I find unpalatable, but I've got to admit that the evidence is backing it up.
In a world where capital flows are becoming dominated by equity investments rather than government securities, it appears that the CB action that causes your currency to rise is actually an easing of rates. Of course the ultimate result of that action is probably a hyperinflation.
If this economy continues to weaken, the dollar will drop, but Greenspan will most certainly lower rates. So we should get to find out what happens when this theory is applied.
We might see simultaneous inflation and deflation. I know most people think they cancel, but they don't. The asset deflation is pretty much a given. Stocks and real estate are in secular bear markets. (The Intel haircut is already impacting real estate pricing around here.) Their declines will hurt demand for optional purchases like HDTV and 3G wireless. Overcapacity will contribute to that problem. But if rates are lowered and he succeeds in holding off recession, demand for basic commodities will continue to grow, and commodity inflation will continue. I can think of nothing worse for corporate profitability than deflation of consumer goods coupled with inflation of the raw inputs that make them.
The other possibility, and one I think is the most likely scenario, is that it just doesn't matter what happens to interest rates. On the way up, I had several people telling me that "The Fed doesn't matter any more", and they were largely right. Funding for the boom was coming outside traditional sources, so the Fed was rendered less effective. But as I warned everyone who told me that, this is not a good thing. The last thing in the world you want is to go back to the system of letting the free market determine the price of money all by itself. Humans inherently move in crowds, and the result would be far deeper economic cycles. The job of the Fed is to dampen the natural cycles - prevent the booms from running full speed ahead so that the busts won't be catastrophic.
Given that the Fed has less control over capital formation now, I expect that lowering rates won't do any good. Borrowers are all tapped out, and as I've mentioned many times, money growth requires both a willing and qualified lender and a willing and qualified borrower. This economy is short on both, and a little economic weakness will put this on display.
This is one thing I keep asking myself: what is the right policy move now? If Greenspan kicked off and they asked you to right things, how would you do it? It's probably kinda like taking a plane up really, really high, pointing it straight down at the ground, taking it beyond Vmax, and then handing over the controls. It's probably unrecoverable, a matter of having too much kinetic energy loaded into the system and not enough control surface to matter. But it is interesting to ponder.
BC |
