Radio commentary, December 20, 2008
WBAI, where this show originates, is fundraising this week, so I was pre-empted. That, plus the holiday spirit, sent me to the archives for some encore material for this week’s show. The intro and commentary are new, though. Same drill for next week, too, I’m sorry to say. But all new material the week after, the first show in 2009.
The major economic news of the past week was the Federal Reserve’s decision to cut the short-term interest rates under its most direct control to 0, or close to it. This is a historic low. Never before in the U.S. have interest rates gone to 0. But it’s not just the Fed doing it—last week, the Treasury sold one-month bills with a yield of 0. The reasons for these twin zeroes are somewhat different. T-bills hit 0 because investors are scared and want to park their money somewhere with minimal risk. Despite our troubles, the U.S. Treasury is still the safest haven in the world, especially for a very short-term loan. The Fed cut interest rates to 0 because it’s afraid the financial system will implode, and take the real economy along with it.
But with interest rates, it’s not easy to go below 0. Yes, T-bills briefly traded below 0 for a while—meaning that if you bought one for, say, $1,000,050 now, you’d get $1 million back when it matured in a few weeks. Banks could also pay negative interest rates, meaning they’d charge you for holding your money. Some monetary reformers over the years have suggested some version of negative interest rates to encourage people to spend money rather than hoard it. But since one of our problems is people having spent too much money that they don’t have, that doesn’t seem like a prescription ideally suited to the moment.
So, for all practical purposes there’s what pundits call a zero bound on interest rates. The Fed is highly aware of the fact that they’ve hit that wall, or floor if you prefer, so they’re also experimenting with some unusual techniques.
Historically, in conducting monetary policy, they’ve dealt only in short-term U.S. Treasury paper. When they want to tighten policy, they sell bills and notes in the market; banks buy them, and cash is drained out of the system. When they want to loosen, they buy bills and notes, using money created out of thin air, and add cash to the system. These moves have a strong influence on short-term interest rates, but not long-term rates. Long-term rates are generally set by bond traders, bsaed on their evaluations of the future course of the economy, interest rates, and inflation. When the Fed is tightening, long-term rates usually rise, and when it’s loosening, they often fall, but not always. Recently, traders have been so nervous about the future that long-term rates didn’t come down anywhere near as much as short-term rates have. And since long-term rates have a profound influence on mortgage markets and corporate investment, that stickiness has hindered financial and economic recovery.
So the Fed is plunging directly into the long end. They’re already buying up mortgage bonds issued by Fannie Mae and Freddie Mac; this has helped bring mortgage rates down. Of course, it’s really hard to get a mortgage, and few people are dying to buy houses, so the effects of lower rates are limited, But they’re pushing things as hard as they can. And it’s also likely that they’re going to buy long-term government bonds too, if rates don’t come down. They have come down in recent weeks, but if they kick back up, the Fed will buy with both hands to push them back down.
In the jargon of the trade, these bond purchases are called “quantitative easing.” The Bank of Japan did a lot of this in the 1990s, when that country was suffering from a long stagnation after their 1980s credit bubble burst. You frequently hear market pundits say that this policy didn’t work for Japan. Didn’t work compared to what? Yes, it didn’t generate prosperity, but let’s look at the record. After a speculative mania of world historic proportions led to a bust of equally impressive magnitude, Japan suffered not a depression, but a decade of stagnation. The unemployment rate, as computed by our Bureau of Labor Statistics to conform to U.S. definitions, maxed out at 5.4% in 2002. The 1992-2007 average was 4.0%. Over that same period, the U.S. jobless rate averaged 5.3%, a hair under Japan’s worst, and hit a high of 7.7% in 1992, more than 2 points above Japan’s worst. Our latest reading is 6.7%, almost a point and a half above Japan’s worst. According to the OECD, Japan had a poverty rate of 15.3% in the late 1990s (in a bust), vs. 17.0% in the U.S. (in a boom). Oh, and its auto industry never teetered on the verge of bankruptcy. If that’s what “didn’t work,” means, we should be so lucky.
In other news, there are some signs of stabilization in the real economy and the markets. Some short-term interest rates are coming down. (I said earlier that short-term rates were very low, but that’s mostly true of low-risk assets like government bonds. Rates for private borrowers remain stubbornly high, but they are showing signs of coming down.) First-time claims for unemployment insurance fell slightly last week, confounding expectations for a rise, but they remain elevated. The Conference Board’s leading index fell in November, but by half as much as October. That suggests the economy is still weakening, but at least not at an accelerating pace. But remember, we probably will still have six or nine more months of recession even after the leading index bottoms. And we’re still not there yet.
It looks like the incoming administration and Congress are going to put together a stimulus package approaching $1 trillion. This is serious money, and it looks like they’re going to use it for good stuff, like infrastructure rebuilding, support to state and local governments, green jobs, and unemployment insurance extensions. That’s some of the most cheering news to come out of the transition so far. It’s almost enough to take your mind off the invitation extended to that revolting creep Rick Warren. Almost.