Thoughts on money, interest, etc.

Well, today the Fed has decided to “boldly go where no man has gone before” taking rates essentially down to zero.  I can’t help thinking that they may be pushing on a string here.  I doubt that the reason that loan volume is way down (i.e. banks aren’t lending) is because rates have been too high – I think instead that it’s a combination of fear that things are so bad that no one will repay, along with rational re-thinking of risk (i.e. things really are pretty bad, so don’t make risky loans anymore).  Note also that with the fed paying interest on reserves, there’s even less reason for banks to make loans!  The Fed seems to want to lower long-term mortgage rates, which will presumably keep housing prices a bit higher than otherwise (since people can borrow more for the same income), but may make it very hard to unwind out of these really low rates, since that move will inevitably slow things right back down.

I always found it a bit odd that during the housing price run-up, this was never spoken of as ‘inflation’ (we were constantly assured that we had low inflation – and we did in some areas, such as Chinese-made goods), but clearly it was inflation (since the reversal of housing prices is surely thought of as deflation).  Now that the correction is happening, the consequences are so painful that no one ‘in charge’ wants to let it continue, so they will try all sorts of things to keep certain asset prices propped up.  The question is whether this approach will simply let the problem slowly drag on…

A whole lot of money/wealth has gone up in smoke in recent months (401k’s are now 201k’s), and despite the fact that the Fed and the Treasury are creating lots of new money, it’s not nearly as much as has disappeared.  Still many are worried about longer-term inflation…  See this bit from today’s NYT story “Fed Cuts Benchmark Rate to Near Zero” by Edmund Andrews:

“At some point, and without knowing the timing, the Fed is going to have to destroy all that money it is creating,” said Alan Blinder, a professor of economics at Princeton and a former vice chairman of the Federal Reserve, said the central bank. “Right now, the crisis is created by the huge demand by banks for hoarding cash. The Fed is providing cash, and the banks want to hoard it. When things start returning to normal, the banks will want to start lending it out. If that much money is left in the monetary base, it would be extremely inflationary.”

I see that the dollar is now resuming its drop (I suspect the main reason it was strengthening is that many people were having to get dollars to cover other losses).  Here’s my prediction: continued drop in the dollar, leading to an inflation of all imported things, simply due to loss of buying power of the dollar.  Sooner or later lending volume will start back up, and in general business will pick up, but we may have taken a pretty big long-term hit on the American ‘standard of living’.

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