End the Rate Increases -- We don't need a recession to tame inflation.

Wall Street Journal ^ | October 19, 2004 | JOHN MAKIN

[OESY]

The U.S. economy is heading for a post-stimulus hangover. The double drag from higher oil prices (a tax increase) and higher short-term interest rates is not helping. If we aren't careful, we'll have a recession in 2005. That possibility makes even more dangerous the tax increases being proposed by John Kerry....

Going forward, sustaining growth will require three key steps. Although the leeway for further tax cuts is limited, current tax cuts should be made permanent in order to give households and firms greater confidence about the future tax environment while avoiding additional tax burdens to the substantial drags already hitting the economy from higher energy prices. Beyond that, marginal tax rates should be further reduced with revenue losses recouped by eliminating tax preferences.

Second, the Fed needs to sharply re-examine its concept of the current neutral real fed-funds rate.... The rationale sometimes heard, that the Fed needs to raise the fed-funds rate in order to have the leeway to cut it in the future, is essentially silly if such rate increases themselves lead only to the need for future rate cuts.

Finally, whatever the growth environment, the U.S. needs to reassert its leadership in the trade arena and avoid restrictive trade practices both at home and abroad with renewed vigor.

The only one of these three steps that can be undertaken quickly is an end to rate increases by the Fed until the pace of growth becomes clear in coming months. With inflation and growth both falling, there is no inflation risk attached to a pause in Fed rate increases. We don't need a recession to tame inflation -- the usual rationale -- and we certainly don't need a recession that reignites deflation risks.

[OESY]

Mr. Makin, resident scholar at the American Enterprise Institute, is a principal at Caxton.

[Mr Ramsbotham]

You can't cure inflation with a recession. You cure inflation by limiting the growth of the money supply, which may cause a recession. However it's the limitation of money supply, not the recession, that effects the cure.

[Reaganghost]

Mr. Makin has his eye on the wrong bogey. What we should be ending is the Federal Reserve and let the market set rates.

[David]

This article is just dead wrong. It is wrong about the condition of the economy; and it is wrong about the cure. The perscription is designed to address adverse conditions in the Wall Street investment banking industry and if implemented will have the result of making the general economy worse.

The current economic condition is the result of excess debt, created during the mid 1990's. Lower than market money rates in the period encouraged development of the problem; lower than market money rates since have exacerbated the problem.

The principal economic problem of the day is that an excessive portion of current liquidity flow is being applied to debt service on preexising debt incurred in transactions that date back to the 1990's--thus there is no excess liquidity to use for new financial commitments. No one is buying cars or other manufactured assets because purchasers don't have sufficient liquidity to pay for them.

The problem of the day is not inflation--the money supply is shrinking, not expanding. Prices of many commodities are increasing because of supply demand considerations which is an additional burden on current liquidity flow.

However the fact is that the supply of cheap energy is running out. Our agricultural system is designed to convert energy to food. Most manufacturing converts energy to finished goods. Do we think that lower interest rates are likely to result in additional energy supply? No way that we can see. In fact, cheaper money will reduce the trading value of the dollar and result in increased prices for energy.

However energy costs and the result of increased energy prices are not the significant issue. The problem is excess debt which will simply become worse if the cost of creating additional debt is reduced.

Interest rates should be raised at the next fed meeting to 4.75%. The debt service burden should be addressed directly by Congress by liberalizing access to the Bankruptcy Courts to write all secured debt and asset security to market in a summary fashion. This will have the effect of freeing up cash flow for application to new financial commitments which will in turn result in increased investment and expansion of production and incomes.

The US has no domestic savings--substantially all investment is funded by external liqudity. We need to encourage domestic savings by raising interest rates above the stabilized money rate which ought to dictate interest rates increasing further as soon as the economy can be seen to be expanding.

[KarlInOhio]

The double drag from higher oil prices (a tax increase)

Grrr! High oil prices are not a tax increase. Taxes are charges from government. Oil prices are not a charge from our government. They are a charge from oil producers (some government, some private) and are set by the market.

I don't like high oil prices, but don't confuse them with the bill on April 15.

[KarlInOhio]

Interest rates should be raised at the next fed meeting to 4.75%.

Which rate should be increased? The prime rate is already at 4.75%. The federal funds rate is at 1.75%. If that's the one you want to raise, you would be asking for a 300 basis point increase. Thanks a pantload for wanting to jack up my mortgage rate by 3%.

The US has no domestic savings--substantially all investment is funded by external liqudity.

What is counted as "savings"? Does it include just my savings and checking accounts? Does it include my 401k? My stock investments and money market account at my broker? The money market account my insurance company runs?

Bank checking and savings accounts are for chumps. The only reason I have more than a couple of hundred dollars in my checking account at the end of the month is if I screwed up counting. Everything else goes to the broker or to pay off my mortgage. For me banks are there for cashing checks, writing checks and using the ATM. They aren't there for saving money.

[TigerLikesRooster]

Re #4

Bump!

Please flag me again if you come across another interesting thread.:)

[ex-snook]

"Finally, whatever the growth environment, the U.S. needs to reassert its leadership in the trade arena and avoid restrictive trade practices both at home and abroad with renewed vigor. "

Sound like curing the patient with further bleeding. Trade needs to be balanced - we buy from you - you buy from us. Exporting both the industry and the money to buy America is lose-lose.

[Fyscat]

well said

[B4Ranch]

>>Thanks a pantload for wanting to jack up my mortgage rate by 3%.<<

Do you have a variable mortgage? Myself, I would get a fixed one.

[B4Ranch]

A cold winter is going to be a heavy burden to everyone in America.
__________________________________________________________________________

On Friday, U.S. Federal Reserve Chairman Alan Greenspan said higher oil prices this year ($20-a-barrel) were the equivalent of a tax on Americans amounting to about 3/4 percent of the U.S. gross domestic product, and he warned of more serious negative consequences if prices moved "materially higher."

"In terms of immediate impact, the economy certainly has been slower in 2004 than in 2003," Olson said, adding that the Fed was looking at both the immediate and long-term effects of rising oil costs.

Worries about winter inventories are unlikely to disappear any time soon. U.S. oil production in the Gulf of Mexico is still running low after pipeline and platform damage from Hurricane Ivan in September.

Gulf of Mexico output is at 73 percent of its normal rate of 1.7 million barrels per day and some fields are expected to remain shut beyond the end of the year, a U.S. government resource agency said.

The shortfall has limited refiners' ability to build up heating oil stocks, which at 50 million barrels are 10 percent below last year, weekly government data showed last week.

Heating oil supplies in the Central Atlantic region, a major distribution point for the heavy consuming U.S. Northeast, are running well below average.

http://www.reuters.com/financeNewsArticle.jhtml?type=businessNews&storyID=6533214

[redgolum]

No offense, but what happens when the stock market or housing bubble crashes? Property values are very cyclical, and we are past do for a dramatic decrease in the average price for land. We are in much the same place Japan was in the late 80's early 90's. The stock market is way over priced, our real estate is to high, and to make it worse many are trying to convince the US that getting rid of the manufacturing base is a good thing.

[B4Ranch]

Global trade requires the transportation of a wide assortment of commodities. At the same time, retail consumption has led to aggravating US trade gaps which have fostered Asian growth, and US indebtedness.

Take the Finance Quiz"

This is the question being asked.

Q.U.S. markets have had the best returns during the administrations of Presidents from which political party?

It's halfway down the page on the right.

[snowsislander]

o offense, but what happens when the stock market or housing bubble crashes? Property values are very cyclical, and we are past do for a dramatic decrease in the average price for land. We are in much the same place Japan was in the late 80's early 90's. The stock market is way over priced, our real estate is to high, and to make it worse many are trying to convince the US that getting rid of the manufacturing base is a good thing.

One different point is that the Japanese had strong savings to fall back on. We don't.

[B4Ranch]

If you are sincerely concerned, sell your property now and put it in a secure investment. This will give you the cash to ride out any upcoming recession.

[David]

"Interest rates should be raised at the next fed meeting to 4.75%.

Which rate should be increased? The prime rate is already at 4.75%. The federal funds rate is at 1.75%. If that's the one you want to raise, you would be asking for a 300 basis point increase. Thanks a pantload for wanting to jack up my mortgage rate by 3%."

I guess I thought we were sophisticated enough to know that the only rate the fed can control at its next meeting is the funds rate (at which banks loan to each other). So yes, I think that instead of the 25 bps the futures market is pricing in, I think they should raise 300 bps. (Recognizing that as a consequence of political considerations, that is not going to happen and instead, the fed is presumably going to go up 25 bps a month for the next 12 months.)

There is a fed paper in general circulation that concludes that a rate between 4.5% and 5% would be most appropriate to current monetary conditions. So I picked the middle.

" What is counted as "savings"? Does it include just my savings and checking accounts? Does it include my 401k? My stock investments and money market account at my broker? The money market account my insurance company runs? Bank checking and savings accounts are for chumps."

No we weren't talking about savings accounts with a bank, we were talking about savings in the economic sense--accumulation of liquidity for purposes of capital formation; to use or lend for capital asset acquisition purposes.

Includes amounts actually set aside in any 401(a) plan including but not limited to those with (k) benefit provisions.

Point is that since the early 1990's, consumption spending in the US has equaled or exceeded current liquidity flows in almost all periods. Further, during the 80's, although in some periods we had positive saving numbers, the amounts were nominal, well below amounts required to maintain a competative capital plant.

Thus all US capital investment is supported by borrowing or from investment of US dollars from offshore investors. Not necessarily a problem as long as you are not concerned that your capital plant is now owned by overseas investors.

My own view is that it is not wise financial management to have debt on personal use assets--cars, personal use real estate (residences; seasonal property; etc.). Not everyone agrees.

But if you do, you need to realize that at current rates, VRM debt is selling for (interest) less that the risk adjusted capital cost of the loan so you are exposed to having the rate go up if liquidity gets marked to market. That is why many do as B4 suggests and borrow at higher fixed rates.

Point really is that increasing the fed funds rate to reasonable market will have an encouraging effect on capital formation at every level.

[PersonalLiberties]

Always interesting input. Thanks for the bump. Seems to make sense it would protect the value of the dollar for energy purchases as well as encourage investment.