Interest rates, the Middle East and the movies

Business Times - 02 Nov 2007
Bernanke playing into the hands of Bush & Co

INVESTORS on Wall Street were expecting that when the policymaking committee of the US Federal Reserve met on Wednesday, its members would agree to cut the federal funds rate by a quarter percentage point to 4.5 per cent.

And surprise, surprise! That's exactly what happened, which is the good news, at least as far as short-term effects are concerned - and perhaps also the bad news, if one considers the long-term repercussions of the latest move by the US central bank.

The Fed had cut the federal funds rate (the rate at which banks lend to each other) by half a percentage point at its previous meeting of the Open Market Committee on Sept 18, responding then - as it did this week - to the pressures coming from the financial markets.

September's decision had clearly helped to calm the then anxious credit markets. But then, the credit markets, facing more bad financial news (including new losses as a result of the continuing crunch), were again exhibiting new signs of panic and sending another SOS message to Fed chairman Ben Bernanke: Please, cut the rates again!

And Mr Bernanke seemed to have fulfilled these expectations this week. That is going to make it cheaper for businesses to borrow money and ease the pressure on credit card holders and home owners trying to readjust their rate mortgages. And there is little doubt that had Mr Bernanke and his colleagues refrained from cutting rates on Wednesday, they would have been blamed for helping set off the inevitable hysteria on Wall Street in the form of a falling Dow.

But while September's decision by the Fed could be justified by arguing that the central bank was operating based on the consideration of the 'real' economy and attempting to head off a potential recession that could have devastating impact on the US and global economies and that it was not trying - as some critics had argued - to bail out irresponsible hedge fund managers, this time that rationale sounds a bit hollow. This is especially so on the same day that a government report presented an upbeat perspective on the US economy, suggesting that it expanded faster than expected in the third quarter, led by a rise in consumer spending and exports.

In fact, the GDP report indicated that the rate of growth of the US economy was the fastest since the first quarter of 2006 and that consumer spending expanded at more than twice its rate in the second quarter.

These figures could serve as ammunition in the hands of inflation hawks who could argue that the risk of inflation is greater than expected and that the cut in interest rates could increase the inflationary pressures. But the Fed's policymakers could respond that they made their decision this week based on their view that the continuing housing downturn and credit market crunch are signs that the American economy is still at risk since it could lead to cuts in sales and production by companies and increase the chances that the economy could head towards a recession.

The US employment data that is going to be issued today could help settle the debate between the inflation hawks and those who are worried that the housing and credit problems would eventually drag the economy into recession - by indicating to what extent the financial problems have affected job growth.

If, indeed, the reports issued this week suggest that the 'real' economy is doing well under the circumstances, the interest rate cut on Wednesday could be perceived as just another effort to pump money into the economy as a way of cheering up the fat cats on Wall Street and of sending a message to other borrowers that it's business as usual and that there's no need - right now, that is - to file for bankruptcy. And if, indeed, the current liquidity crunch is real, both the wealthy hedge fund manager and the little guy who cannot pay the mortgage on his house will have to face the music at some point in the future.

And, ironically, it would be a Republican administration and the Fed chairman that it had appointed that seem to be trying to thwart the operation of the free market and in the process inflating a financial bubble while introducing the 'moral hazard' into this dangerous equation.

After his failure in win re-election in 1992, George H W Bush blamed then Fed chairman Alan Greenspan for his loss, arguing that he would have won if Mr Greenspan had lowered interest rates before the elections. From that perspective, like General David Petraeus, who is expected to create the impression that Iraq is not collapsing, Mr Bernanke now seems to be trying to create the sense that the financial bubble is not bursting - playing right into the hands of the Republican White House.

Copyright © 2007 Singapore Press Holdings Ltd. All rights reserved.
And please read my The Tunnel at the End of the Light and When Reel Tales Rewrite Real History


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