Worthwhile read...
financialsense.com
From the last paragraph....
(one only need look at the IT debt debacle to see where this can lead)
The Grand Experiment
So where does this leave us today? The Fed is still in the fire fighting mode. More interest rate cuts are sure to follow. The closer they push rates down to zero, the greater the danger that the US will enter a Japan-style liquidity trap. A liquidity trap occurs when lower interest rates simply have no impact on consumer and corporate spending and borrowing plans. This is what happened in Japan in the 1990’s. It hasn’t happened here. The Fed was quick to act beginning this year in January. It has been working overtime. Lower interest rates have helped to reduce financial sector strains. The spread between short and long-term interest rates has helped banks and kept the financial system liquid. Lower interest rates have also helped consumers to refinance mortgages. Near zero interest is what is driving current consumer spending. Consumers are borrowing and spending. Lower interest rates have reduced borrowing costs for businesses and consumers. It is what is currently holding up housing. Lower rates have also put a temporary floor underneath the financial markets by making fixed income investments less attractive.
The question is whether spending today is robbing Peter to pay Paul. Is current spending being borrowed from tomorrow's spending? The danger is that current consumer and corporate debt levels leave little room for expansion. So debt limits may impose limitations on spending that could lead to a self-feeding cycle of declining consumer and corporate spending. This could accelerate if profits continue to shrink and job layoffs continue to grow. If retrenchment takes hold in either sector, it may be difficult to reverse. This could then lead us to that liquidity trap that many economists don’t think is possible because of the Fed’s aggressive rate cuts. The liquidity trap in Japan was blamed on a reluctant easing on the part of its central bank and a failure to deal with Japan’s banking problems that were infested with bad loans. Whether we are headed for trouble or not, we should know soon enough. If the economy doesn’t respond and continues to deteriorate in the face of lower interest rates, or if the stock market fails to rally to new highs, then trouble will have arrived. Policymakers will have run out of options and that’s when the real fireworks will begin.
So far the greatest asset bubble of the last century has been partially deflated without generating a systemic crisis. Investors have suffered massive losses in their wealth. The job market is soft and more jobs are being lost each week. The technology industry is still suffering from a capacity glut and the manufacturing sector is still contracting, but the ship is still afloat. The clock is ticking and we still have those wild cards of derivatives, oil, and war. We should know within the next two quarters if Mr. Greenspan’s grand money experiment will have worked. If he is able to reinflate the economy, resurrect the stock market bubble, keep gold and silver prices from rising, keep a lid on energy prices, deflect the collateral damage from war, bring world peace, and tame the derivative monster from turning into a financial contagion, he would have rightfully earned a place on the cover of Time magazine. He would indeed have become Greenspan Superman. ~ JP
© 2001 James J. Puplava |
