The author states the current perception. That perception didn't exist summer of '97. It seems to be chic to believe that debt is pulling down GNP growth of certain foreign economies. The foreign economies just grew too fast because they were driven by their competitive wage rates, so they had to slow down. The slow down has reminded everyone that banks can become over-extended. So when economies slow it allows the banks to re-liquify. Weak sisters die.
None of this process should strictly motivate FED policy. As Teitmeyer said last week, each country must determine policy based upon what is happening internally there, not based on other economy's circumstances. The FED to a certain extent is embracing the current perception in order to prevent a fear syndrome from developing where people choose actions that are deleterious to everyone. They're throwing water on a lit match. I don't think we can yet extrapolate that to a more general bailout. Gradualism always fails, but on the down side of rates, given our propensity to inflate, gradual action has to be the best move. Maybe in several months they will lower fed funds another 25 basis points. If that is consistent with our domestic circumstances, one can hardly reach the conclusion that they're overdoing it.
The FED can't bail out Japan. The trade in the dollar commandeers the world central banks. $300 billion in international transactions each day goes through the NY Fed. The FED isn't in charge; they never were. The free market in money, your and my willingness to loan, determines the cost of money. We let the banks set rates because it is convenient. However, it is also potentially disastrous if central banks go against the will of the people, and try to do their usual thing.
That thing starts with FED acting to support economies by money creation and when economies have revived, they can't quit creating because they fear the economies will slide back into no growth or worse. They end up creating money to prevent rates from rising. They try to create fiat prosperity. Long after, they never can see where they went wrong. They go wrong because they interfere with the market's adjustments to the cost of money under the pretense to knowledge that they know where equilibrium lies. Once you've started down the path of undisciplined money creation, money growth in excess of productivity growth, you can't disengage. Thus, if the FED doesn't exercise discipline, the dollar will decline.
A weak dollar and powering up Asian tigers is a financial and real economy blow to the US. Roach claims that the debt and weak economy effects will force continued strong money growth. What happens if the money growth does the trick quickly and things are back to pre-summer '97? They fell apart quickly and in spite of debt overhang, they can recover quickly. Perhaps the debt gives the machine leverage. In such an environment FED must reverse policy. They believe they can walk the fine line. All the FEDs throughout history have believed the same. None have been successful.
For FED to be successful now, they have to back off from overt money creation, outright purchases of government securities. If they don't the rapidly rising money supply will create monetary inflation. That means lots of money during a period of slowing output. More money per unit good. Initially that state causes production to rise and reverse the slowing, but the GNP response happens with a lag. It is at the real economy revival point that the FED must back off. If they continue with even so much as a slight accommodation, the more base growth ends up in higher prices disproportionate to higher output and before the new output is available. I don't have to tell you what happens when striking unions are striking for compensation protection against rising prices.
This all means that the current circumstances are constructive for equities. They got a good whacking four days in August, so most of the trouble at least for the intermediate run is behind. Foreign economies have slack. We don't have much. If Roach is right and foreign economies remain weak, it will only be the case because foreign central banks refuse to engage in money creation. I doubt that will happen because as is well-known, the foreign bank over-extension forces their hand sooner or later. Fiscal policy isn't enough. They need to generate raw money, but eventually they and the FED will have to exercise discipline and stop pumping. |
