This was certainly an interesting week for the global economy. A low level index trader at a French bank loses $7.2 billion without anyone knowing. The bank unravels it's investments and the international markets tank. The US markets tank. The Fed proactively responds with a 75 basis point drop in the fed rate. The markets rebound a bit (maybe it wasn't a crisis after all?). Then the President announces an economic stimulus package to give the economy a "shot in the arm". Crazy week.
Looking back, there were many intertwined, profound issues that were highlighted. Let me comment on each:
It's the (Global) Economy, Stupid
It still remains to be seen to what extent the $7.2 billion losses at Societe Generale in France caused the decline in the international markets on Monday. But, it appears that it certainly didn't help things. The bank quickly tried to unwind in just 72 hours the unauthorized trades its rogue trader had made over several months. That news didn't quite make it to the general press, though. So, it certainly contributed to the volatility in the European markets on Monday. The Fed, presumably, misread that and overreacted. At any rate, I'm not qualified to pass any judgements on the Fed, but I can add some commentary here.
The markets are so incredibly intertwined at this point, it seems extremely difficult for the individual central banks to maintain adequate oversight and influence over them. All the countries are so invested in each other now. China Development Bank, for example, almost made a $2 billion cash injection into Citigroup (Citi later turned to other nations instead when the deal fell through). It's not surprising that billionaire George Soros this week called for a "new sheriff" to regulate the financial markets. The markets are so complex, a downturn in the US mortgage industry easily has far reaching implications across the world.
The Challenge for the Central Bank
A case in point for the challenge the central banks are now facing is the real potential for stagflation in this US recession (if this is a recession). The US economy is declining yet commodity prices are continuing to increase due to heavy demand from abroad in booming economies like India and China. If you're the Fed, what do you do?
Or, this week's example was also good. The global markets are rapidly declining (presumably because of the US mortgage mess). What do you do? In this case, they made the emergency rate cut. But was that really the right decision? They really only have two or three tools in their tool bag, and none of them really address the core issue. The only real solution is long-term and private - innovation and competitiveness.
It's no wonder the Presidential debates are shifting to the economy.
The Political Business Cycle
To add to the flames (so to speak), you also have an unpopular president in office and it's an election year. The politicians, of course, want to throw in their solution to the problem with an economic stimulus package. What's the problem with that? All the Keynesians are psyched to cut a $600 rebate check for the average middle-class taxpayer that they claim will immediately get injected right into the economy via consumer spending. An attractive proposition. And to Bush's point, he wanted something simple, understandable, and that would have an immediate impact. The rebate check sounds like all those things. Unfortunately, it's not. It's just "feel good economics".
There's virtually no empirical evidence that tax rebates lead to quick economic turnarounds. The reason is that consumer spending is really driven by long-term income potential and not by small fluctuations in yearly income. It's what Milton Friedman called "permanent income". A $600 tax rebate is viewed as short-term windfall and is going to go right into your savings account or to pay off debt. You're not going to buy more food or clothes or other consumer goods. Both situations (saving or paying off debt) have no impact on consumer spending and basically just offset government debt. There's no net positive effect on the economy at all.
But, it makes a good news story and makes both political parties look like they really care. If they really cared, they would make tax cuts permanent or focus on a totally different type of taxpayer.
But I'll leave that for another post ...
Looking back, there were many intertwined, profound issues that were highlighted. Let me comment on each:
It's the (Global) Economy, Stupid
It still remains to be seen to what extent the $7.2 billion losses at Societe Generale in France caused the decline in the international markets on Monday. But, it appears that it certainly didn't help things. The bank quickly tried to unwind in just 72 hours the unauthorized trades its rogue trader had made over several months. That news didn't quite make it to the general press, though. So, it certainly contributed to the volatility in the European markets on Monday. The Fed, presumably, misread that and overreacted. At any rate, I'm not qualified to pass any judgements on the Fed, but I can add some commentary here.
The markets are so incredibly intertwined at this point, it seems extremely difficult for the individual central banks to maintain adequate oversight and influence over them. All the countries are so invested in each other now. China Development Bank, for example, almost made a $2 billion cash injection into Citigroup (Citi later turned to other nations instead when the deal fell through). It's not surprising that billionaire George Soros this week called for a "new sheriff" to regulate the financial markets. The markets are so complex, a downturn in the US mortgage industry easily has far reaching implications across the world.
The Challenge for the Central Bank
A case in point for the challenge the central banks are now facing is the real potential for stagflation in this US recession (if this is a recession). The US economy is declining yet commodity prices are continuing to increase due to heavy demand from abroad in booming economies like India and China. If you're the Fed, what do you do?
Or, this week's example was also good. The global markets are rapidly declining (presumably because of the US mortgage mess). What do you do? In this case, they made the emergency rate cut. But was that really the right decision? They really only have two or three tools in their tool bag, and none of them really address the core issue. The only real solution is long-term and private - innovation and competitiveness.
It's no wonder the Presidential debates are shifting to the economy.
The Political Business Cycle
To add to the flames (so to speak), you also have an unpopular president in office and it's an election year. The politicians, of course, want to throw in their solution to the problem with an economic stimulus package. What's the problem with that? All the Keynesians are psyched to cut a $600 rebate check for the average middle-class taxpayer that they claim will immediately get injected right into the economy via consumer spending. An attractive proposition. And to Bush's point, he wanted something simple, understandable, and that would have an immediate impact. The rebate check sounds like all those things. Unfortunately, it's not. It's just "feel good economics".
There's virtually no empirical evidence that tax rebates lead to quick economic turnarounds. The reason is that consumer spending is really driven by long-term income potential and not by small fluctuations in yearly income. It's what Milton Friedman called "permanent income". A $600 tax rebate is viewed as short-term windfall and is going to go right into your savings account or to pay off debt. You're not going to buy more food or clothes or other consumer goods. Both situations (saving or paying off debt) have no impact on consumer spending and basically just offset government debt. There's no net positive effect on the economy at all.
But, it makes a good news story and makes both political parties look like they really care. If they really cared, they would make tax cuts permanent or focus on a totally different type of taxpayer.
But I'll leave that for another post ...
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