Monday, July 21, 2008
The financial press says Fed Chairman Bernacke is faced with a tough choice.
Is he?
The choice posed by many in the financial press and the media at large is "Should the Fed raise interest rates to fight inflation and risk a slow down in the economy or should it lower rates, stimulate growth and risk inflation?"
Here's the disclaimer. I am not, nor do I claim to be an economist. Having said that, the economists aren't demonstrating a consensus so what do I have to lose? Here's why I don't think there's really much of a choice.
Traditionally, raising interest rates slows borrowing which slows spending and capital investment. The result is a slowing of economic growth. As I look at today's financial landscape I believe that's already occurred. The banks, because of the liquidity crisis they face as a result of their subprime lending faux pas, are severely limiting their lending activities. A few banks even have their "loan" officers pursuing depositors instead of borrowers in order to regain liquidity.
Many banks are also seeking infusions of capital to strengthen their balance sheets. Adding significantly to their loan portfolios would make it more difficult to attract investors and protract the process of regaining a more traditional debt-to-equity ratio on their balance sheets.
Finally, business owners are financing their growth through profits. They are not borrowing more money in the uncertain economy we're facing. Isn't it amazing how these business people, many with little or no finance background, seem to make the right choices when the financial gurus are uncertain about which direction to take?
It's counter-intuitive, but the traditional result from raising interest rates - a slowing economy - has already occurred. Raising interest rates will not significantly slow the economy from here, if at all. The real impact that higher rates may have is in pushing businesses, that are barely hanging on, over the edge into the abyss. If the interest rate hikes are small enough, even this impact will be minimal.
So, Mr. Bernacke, this non-economic business advisor votes for a slight increase in rates. Just enough to avoid inflation, not enough to push marginal businesses into bankruptcy. The economy has already slowed.
If there are other economic perspectives you'd like from this non-ecomomic advisor, send me an email at dale@furtwengler.com. I always have an opinion and you always have the right to ignore it. Be well and keep smiling!
Is he?
The choice posed by many in the financial press and the media at large is "Should the Fed raise interest rates to fight inflation and risk a slow down in the economy or should it lower rates, stimulate growth and risk inflation?"
Here's the disclaimer. I am not, nor do I claim to be an economist. Having said that, the economists aren't demonstrating a consensus so what do I have to lose? Here's why I don't think there's really much of a choice.
Traditionally, raising interest rates slows borrowing which slows spending and capital investment. The result is a slowing of economic growth. As I look at today's financial landscape I believe that's already occurred. The banks, because of the liquidity crisis they face as a result of their subprime lending faux pas, are severely limiting their lending activities. A few banks even have their "loan" officers pursuing depositors instead of borrowers in order to regain liquidity.
Many banks are also seeking infusions of capital to strengthen their balance sheets. Adding significantly to their loan portfolios would make it more difficult to attract investors and protract the process of regaining a more traditional debt-to-equity ratio on their balance sheets.
Finally, business owners are financing their growth through profits. They are not borrowing more money in the uncertain economy we're facing. Isn't it amazing how these business people, many with little or no finance background, seem to make the right choices when the financial gurus are uncertain about which direction to take?
It's counter-intuitive, but the traditional result from raising interest rates - a slowing economy - has already occurred. Raising interest rates will not significantly slow the economy from here, if at all. The real impact that higher rates may have is in pushing businesses, that are barely hanging on, over the edge into the abyss. If the interest rate hikes are small enough, even this impact will be minimal.
So, Mr. Bernacke, this non-economic business advisor votes for a slight increase in rates. Just enough to avoid inflation, not enough to push marginal businesses into bankruptcy. The economy has already slowed.
If there are other economic perspectives you'd like from this non-ecomomic advisor, send me an email at dale@furtwengler.com. I always have an opinion and you always have the right to ignore it. Be well and keep smiling!
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