One of Ben Bernanke's most controversial theories is his Asian Savings Glut Hypothesis. The Asian Savings Glut Hypothesis shows how high savings rates in China effects the supply, demand and prices of US goods and how these three factors affect US wage rates, unemployment rates, and yields on federal debt (T-Bond Yields).
Here is a brief explanation of how Bernanke sees the interactions between Asia and America. Pretend, for a second, that there are two countries, one named China and the other named the United States. These two countries compete with each other to sell as many basketballs and basketball shoes as possible. China decides that the best way to compete with the US is to keep wages (the amount of money manufacturing employees make per hour) as low as possible. This ensures China that when a consumer is at the store looking at basketballs and basketball shoes, the balls and shoes on the Chinese aisle are always cheaper than the balls and shoes in the US aisle. Therefore, assuming Chinese made balls and shoes are the same quality as US balls and shoes, the Chinese have become more competitive than the US and consumers will buy more Chinese goods than US goods.
That is a simple, obvious concept. The complexities of the Asian Savings Glut Hypothesis occur when we ask how can China constantly keep wages low while at the same time keeping the ball and shoe consumers rich enough to afford the balls and shoes?
The concept that expains this is called the Balance of Payments and will be explained further in the next blog. The balance of payments concepts simply says that money MUST go somewhere. If a consumer pays $10 for a basketball and a ball, and they cost $3 to make, the extra $7 must go somewhere. In America, the $7 would go to wage-earning employees, shareholders, banks, credit cards, etc. In China, since they are trying to keep wages as low as possible, the government creates policies to make sure the extra $7 goes anywhere but to the wage earning employees, credit cards, banks, etc. In fact, the banks are so controlled by the government that loans are dictated to go to only two places: low interest rate loans to large manufacturing companies; or to the purchase of US T-Bonds. When China buys a T-Bond, many effects occur. These will be discussed in the next blog.
Saturday, August 29, 2009
Thursday, August 27, 2009
Bias Economists
The Economics profession has taken a lot of criticism lately for its response to the recession.
The Bernanke Files prides itself on being a pragmatic, unbias analyzer of economic policy. The Bernanke Files believes that most of the well founded criticism of economics probably stems from the political bias and ideological rants that many pundits spew everyday.
For example, today's Paul Krugman Blog exemplifies the profession's ignorant biases. Krugman criticizes Bush for going into debt to the tune 0f $500B. Then every comment is a total acceptance of Krugman's statement, its like his audience is... liberal! So of course he is speaking down to his audience.
But, has humanity come to such mindless, thoughtless following? The Bernanke Files thinks not! The debt had to come from somewhere. The two questions one must ask to be fair are: How much did we pay for the money? (Answer: a measley 3-4%) And is the benefit we recieve from the debt greater than (3-4%+addt'l unseen costs)? Keep in mind that if we did not go into debt, employment or wages (or a combo of both) would be considerably less than it is now.
While many of these questions are semi-rhetorical, it is interesting that Krugman does not even mention the cost/benefit analysis in his anti-Bush rhetoric. When the average reader crosses this, how could he become anything but skeptical at the economics profession?
The Bernanke Files prides itself on being a pragmatic, unbias analyzer of economic policy. The Bernanke Files believes that most of the well founded criticism of economics probably stems from the political bias and ideological rants that many pundits spew everyday.
For example, today's Paul Krugman Blog exemplifies the profession's ignorant biases. Krugman criticizes Bush for going into debt to the tune 0f $500B. Then every comment is a total acceptance of Krugman's statement, its like his audience is... liberal! So of course he is speaking down to his audience.
But, has humanity come to such mindless, thoughtless following? The Bernanke Files thinks not! The debt had to come from somewhere. The two questions one must ask to be fair are: How much did we pay for the money? (Answer: a measley 3-4%) And is the benefit we recieve from the debt greater than (3-4%+addt'l unseen costs)? Keep in mind that if we did not go into debt, employment or wages (or a combo of both) would be considerably less than it is now.
While many of these questions are semi-rhetorical, it is interesting that Krugman does not even mention the cost/benefit analysis in his anti-Bush rhetoric. When the average reader crosses this, how could he become anything but skeptical at the economics profession?
Tuesday, August 25, 2009
A Few Thoughts and Updates
Now that Obama has made the mind-numbingly easy decision of re-appointing Bernanke as Chairman of the Federal Reserve, a few loose ends need to be tied up. First, we are taking Laurence Summers, head of Obama's economic council, off of the Bernanke Arch-Nemesis list. Replacing Summers will be Kentucky Republican Senator John Bunning. Today, in a show of splendid ignorance, Bunning criticized Obama's decision. Then Bunning proceeded to criticize Bernanke for what Bunning called a "delayed response" to the crisis. This puts Bunning on the dreaded Bernanke Arch-Nemesis list and is a good lead into the next loose end that needs to be tied up.
The Bernanke Files argues that Bernanke's response to financial crisis was late... and occurred at the exact right time. Let me explain: to be fair, one must look at Bernanke's response in context with the Federal Reserve's day to day environment. If you a critic says, "Bernanke should have speculated about the future of the economy and put into motion drastic measures to stave off the recession," then it is only fair to say that "Bernanke should ALWAYS speculate about the future economy and put into motion measures to stave off the recession." This means that when unemployment was going from 7% to 3.9% but half way down it turned around for a month (from 5% to 5.1%), Bernanke should have closed down AIG, Bear Stearns, McDonalds and urged Congress to pass Armeggeddon resolutions mandating the purchase toilet paper and water by every American citizen.
But, the Federal Reserve DOES NOT SPECULATE- as crazy as it sounds, the Fed actually waits for facts and data to come to them, then it makes the best decision it can with the resources it has at hand. This maintains confidence in the Fed, and makes sure its decisions are not too drastic, or not enough.
In hindsight, of course Bernanke's response was late... by 20 years. Bernanke, Bush, Clinton, Summers, Bush 1, Reagan, Greenspan and every Congressmember since the 1980's could have made the sub-prime mortage backed security market less leveraged, yet none of them did because rational people don't look into crystal balls to make decisions.
Firstcongerss bunning rule second summers of arch nem
The Bernanke Files argues that Bernanke's response to financial crisis was late... and occurred at the exact right time. Let me explain: to be fair, one must look at Bernanke's response in context with the Federal Reserve's day to day environment. If you a critic says, "Bernanke should have speculated about the future of the economy and put into motion drastic measures to stave off the recession," then it is only fair to say that "Bernanke should ALWAYS speculate about the future economy and put into motion measures to stave off the recession." This means that when unemployment was going from 7% to 3.9% but half way down it turned around for a month (from 5% to 5.1%), Bernanke should have closed down AIG, Bear Stearns, McDonalds and urged Congress to pass Armeggeddon resolutions mandating the purchase toilet paper and water by every American citizen.
But, the Federal Reserve DOES NOT SPECULATE- as crazy as it sounds, the Fed actually waits for facts and data to come to them, then it makes the best decision it can with the resources it has at hand. This maintains confidence in the Fed, and makes sure its decisions are not too drastic, or not enough.
In hindsight, of course Bernanke's response was late... by 20 years. Bernanke, Bush, Clinton, Summers, Bush 1, Reagan, Greenspan and every Congressmember since the 1980's could have made the sub-prime mortage backed security market less leveraged, yet none of them did because rational people don't look into crystal balls to make decisions.
Firstcongerss bunning rule second summers of arch nem
Monday, August 24, 2009
BREAKING NEWS: Bernanke Re-appointed!!!!
The Executive Branch has done little right over the last several years. Today, though, this trend paused for a moment when Barack Obama re-appointed Chairman of the Federal Reserve Ben Bernanke to another 4 year term.
Obama joins George W Bush as being members of the very prestigious club of presidents that has appointed Ben Bernanke as Chairman. Though Bernanke has a long road of him in dealing with the recession and exiting the current monetary situation, he is the right man for the job, hands down.
Bernanke has overseen the worst liquidity crunch in over 70 years. He reacted to the crisis by expanding the amount of money in the financial system. What he will truly go down in history for is his ability to add so much money into the system at the extremely low risk levels that he did; and for adding so much liquidity while keeping in mind he would have to undo the expansion shortly. These two measures have kept faith in the dollar and interest rates low- two important factors for future growth.
Obama joins George W Bush as being members of the very prestigious club of presidents that has appointed Ben Bernanke as Chairman. Though Bernanke has a long road of him in dealing with the recession and exiting the current monetary situation, he is the right man for the job, hands down.
Bernanke has overseen the worst liquidity crunch in over 70 years. He reacted to the crisis by expanding the amount of money in the financial system. What he will truly go down in history for is his ability to add so much money into the system at the extremely low risk levels that he did; and for adding so much liquidity while keeping in mind he would have to undo the expansion shortly. These two measures have kept faith in the dollar and interest rates low- two important factors for future growth.
Wednesday, August 19, 2009
Stimulus vs. Monetary Policy
Monetary policy stimulates the economy by determining the amount of money that is injected into the banking system each month. Fiscal stimulus is money spent directly by the federal government on various projects.
While The Bernanke Files is not totally anti-Stimulus, it has concluded that the current stabilization of the economy had little or nothing to do with Obama's stimulus plan. Several weeks ago, before the "popular" indicators showed economic stabilization, Liberal commentators said the stimulus plan hadn't yet worked because most of the stimulus plan has not been spent. Now, after the "popular" indicators are turning around, those same commentators are saying "See, we told you so! Of course the stimulus is working." In reality, though, ONLY $25 Billion more dollars has been spent since then!!! In a $14,000 Billion economy, of course $25 Billion will make virtually no difference.
There is other evidence that shows that stimulus has done little, much less than the efficiently crafted monetary policy has done. First, if stimulus was working, one would expect people to go out buy things like clothes, toys, toothbrushes, etc. But, as was reported this week, retail sales declined by MUCH MORE THAN ANTICIPATED. Clearly, to any unbiased spectator, one would have to be skeptical of saying the stimulus plan had much, if anything, to do with the turnaround.
Conversely, monetary policy is having a large impact. Econ101 says that stimulus plans work because it replaces the "fearful" investor/consumer spending with government spending. This time, though, the Fed has crafted such efficient monetary policy that interest rates are declining (A2/P2 is way down, the LIBOR-OIS spread is almost back to normal). This makes investors invest more because they can borrow money for less than what they will make off of the money. Investors in turn employee consumers who can then spend money. The Bernanke Files believes the first step, investors investing more, is beginning to take place. Next, down the road, unemployment will turn around because of investment, not the stimulus plan.
While The Bernanke Files is not totally anti-Stimulus, it has concluded that the current stabilization of the economy had little or nothing to do with Obama's stimulus plan. Several weeks ago, before the "popular" indicators showed economic stabilization, Liberal commentators said the stimulus plan hadn't yet worked because most of the stimulus plan has not been spent. Now, after the "popular" indicators are turning around, those same commentators are saying "See, we told you so! Of course the stimulus is working." In reality, though, ONLY $25 Billion more dollars has been spent since then!!! In a $14,000 Billion economy, of course $25 Billion will make virtually no difference.
There is other evidence that shows that stimulus has done little, much less than the efficiently crafted monetary policy has done. First, if stimulus was working, one would expect people to go out buy things like clothes, toys, toothbrushes, etc. But, as was reported this week, retail sales declined by MUCH MORE THAN ANTICIPATED. Clearly, to any unbiased spectator, one would have to be skeptical of saying the stimulus plan had much, if anything, to do with the turnaround.
Conversely, monetary policy is having a large impact. Econ101 says that stimulus plans work because it replaces the "fearful" investor/consumer spending with government spending. This time, though, the Fed has crafted such efficient monetary policy that interest rates are declining (A2/P2 is way down, the LIBOR-OIS spread is almost back to normal). This makes investors invest more because they can borrow money for less than what they will make off of the money. Investors in turn employee consumers who can then spend money. The Bernanke Files believes the first step, investors investing more, is beginning to take place. Next, down the road, unemployment will turn around because of investment, not the stimulus plan.
Saturday, August 15, 2009
Economics Riddle Solution
Several blogs ago the audience was asked what China did with the extra money it receives from having more imports than exports. The technical name for this extra moneythe trade gap, which is hundreds of billions of dollars.
The correct answer is that there are several things it can do, a couple of things it has done, and several things it may do to combat the recession.
First there are things China can do with the extra money. The first thing it can do, which The Bernanke Files has discussed at length, is use the extra money to pay its employees higher wages. The problem with this, of course, is that the USA buys goods from China because their wages are so low! Raising wages would hurt China's most important sector: manufacturing.
Second, China could use the extra money it receives to build up its infrastructure. Highways, ports, buildings, schools, regulators, boats, airports etc. could be built with the extra money. However, this raises two things: the demand for labor and (therefore) wages. Again this hurts their economy because China's economy is built on the assumption of low wages. Also, this kind of spending, when unwarranted, creates bubbles by producing things, like boats, that are not needed by the market participants.
Third, China can and does purchase American T-Bonds at an extroardinary rate. This serves three purposes: it keeps Chinese wages low, it diversifies China's government because the T-Bond is a very safe investment, and it gives American's more money and therefore higher wages. Higher wages and more money give American's more fuel to purchase Chinese goods! This full circle of US cash to China for goods, that same cash back to America so we can buy more goods is very important to the Chinese growth model. Actually, all high exporting countries (Germany, Brazil, India, Vietnam) follow this same model.
Finally, it can use this money to subsidize a certain sector of the economy. For example, China can lend the extra cash to very large manufacturing corporations to make sure they keep making STUFF that Americans buy. But what happens when Americans quit purchasing the STUFF, and China keeps making the STUFF?
It is also important to remember that China receives extra cash from another source: local Chinese citizens that want to SAVE money. Since China wants to stifle local Chinese citizens from buying too much (so that imports do not go too high and other reasons) they can either give the citizens high interest rates so that the Chinese have more incentive to save money, or they can ration goods (like USA did during WWII...hmm, we were the lending nation back then, think theres a correlation?), explicitly by direct rationing or implicitly by keeping wages low and credit card restrictions high.
So basically China has used its own citizen's money to, well, screw over most of the Chinese citizens. Of course, China does this because they believe that in the long run it will pay off.
The next economics riddle should be "So what happens when America goes into a recession and quits buying Chinese goods but China passes a huge stimulus bill and keeps making the goods anyways?" But, this will be such a depressing subject I will save Bernanke fans everywhere a lot of grief and just answer briefly: Nothing good.
The correct answer is that there are several things it can do, a couple of things it has done, and several things it may do to combat the recession.
First there are things China can do with the extra money. The first thing it can do, which The Bernanke Files has discussed at length, is use the extra money to pay its employees higher wages. The problem with this, of course, is that the USA buys goods from China because their wages are so low! Raising wages would hurt China's most important sector: manufacturing.
Second, China could use the extra money it receives to build up its infrastructure. Highways, ports, buildings, schools, regulators, boats, airports etc. could be built with the extra money. However, this raises two things: the demand for labor and (therefore) wages. Again this hurts their economy because China's economy is built on the assumption of low wages. Also, this kind of spending, when unwarranted, creates bubbles by producing things, like boats, that are not needed by the market participants.
Third, China can and does purchase American T-Bonds at an extroardinary rate. This serves three purposes: it keeps Chinese wages low, it diversifies China's government because the T-Bond is a very safe investment, and it gives American's more money and therefore higher wages. Higher wages and more money give American's more fuel to purchase Chinese goods! This full circle of US cash to China for goods, that same cash back to America so we can buy more goods is very important to the Chinese growth model. Actually, all high exporting countries (Germany, Brazil, India, Vietnam) follow this same model.
Finally, it can use this money to subsidize a certain sector of the economy. For example, China can lend the extra cash to very large manufacturing corporations to make sure they keep making STUFF that Americans buy. But what happens when Americans quit purchasing the STUFF, and China keeps making the STUFF?
It is also important to remember that China receives extra cash from another source: local Chinese citizens that want to SAVE money. Since China wants to stifle local Chinese citizens from buying too much (so that imports do not go too high and other reasons) they can either give the citizens high interest rates so that the Chinese have more incentive to save money, or they can ration goods (like USA did during WWII...hmm, we were the lending nation back then, think theres a correlation?), explicitly by direct rationing or implicitly by keeping wages low and credit card restrictions high.
So basically China has used its own citizen's money to, well, screw over most of the Chinese citizens. Of course, China does this because they believe that in the long run it will pay off.
The next economics riddle should be "So what happens when America goes into a recession and quits buying Chinese goods but China passes a huge stimulus bill and keeps making the goods anyways?" But, this will be such a depressing subject I will save Bernanke fans everywhere a lot of grief and just answer briefly: Nothing good.
Friday, August 14, 2009
Inflation at 0.0
The Consumer Price Index data that measures inflation was released today. Inflation is at 0.0% year over year.
Last year at this time inflation was peaking, so this months CPI data is being compared to a peak. Still, inflation hawks and anti-Fed fear mongerers have to be laughing at themselves. Inflation is not currently a problem and won't be for sometime, if at all.
There are two reasons for this. First, the Federal Reserve has very powerful tools to combat inflation. But, even if these are not enough, the Fed will most likely sacrifice low unemployment to maintain low inflation rates. What we need to be worried about is not inflation, but rather that the Fed has to back off of easy monetary policy before unemployment returns to acceptable levels.
Last year at this time inflation was peaking, so this months CPI data is being compared to a peak. Still, inflation hawks and anti-Fed fear mongerers have to be laughing at themselves. Inflation is not currently a problem and won't be for sometime, if at all.
There are two reasons for this. First, the Federal Reserve has very powerful tools to combat inflation. But, even if these are not enough, the Fed will most likely sacrifice low unemployment to maintain low inflation rates. What we need to be worried about is not inflation, but rather that the Fed has to back off of easy monetary policy before unemployment returns to acceptable levels.
Thursday, August 13, 2009
A Whacky Few Days
A few days ago The Bernanke Files hypothesized that some important economic relationships were changing. For example, a few months ago the yields on T-Bonds went up when the market went up. This could be seen as a "flight to safety" relationship because when the markets went down investors became fearful and bought bonds.
But The Bernanke Files is hypothesizing that the motives behind movements will change as investors are driven less by fear and more by other market indicators. This change affects oil, the Dow, bonds, individual stocks and gold.
Today gives us empirical evidence that this trend may be swaying in the direction that The Bernanke Files has argued it will be going: the markets went up, but the interest rate WENT DOWN. This is opposite of what you would have expected a few months ago and supports The Bernanke Files hypothesis.
But The Bernanke Files is hypothesizing that the motives behind movements will change as investors are driven less by fear and more by other market indicators. This change affects oil, the Dow, bonds, individual stocks and gold.
Today gives us empirical evidence that this trend may be swaying in the direction that The Bernanke Files has argued it will be going: the markets went up, but the interest rate WENT DOWN. This is opposite of what you would have expected a few months ago and supports The Bernanke Files hypothesis.
Monday, August 10, 2009
The Past Weeks Odd Movements
Since the recession began there have been certain up/down relationships between several markets. For example, when the Dow Jones went DOWN, the dollar usually went UP. When the Dow Jones went DOWN, crude oil went DOWN. When the dollar went UP, bond rates went DOWN. Most of these movements were explained by pointing out they are "protectionist plays." When the Dow Jones went down, fear made investors seek the safety of the dollar thus raising demand and therefore the value of the dollar.
But!, over the last two weeks these relationships seem to be changing. At the end of last week the Dow Jones skyrocketed up several hundred points. Instead of the dollar and oil decreasing and bond rates going down, the opposite happened. Crude oil has decreased slightly, the dollar has appreciated in value and bond rates have remained unchanged.
The Bernanke Files will be watching this turn of events very closely. While still in the early stages, these changes could signify growth, but also the emergence of inflation risks. The Bernanke Files will keep you updated on this trend as events unfold.
But!, over the last two weeks these relationships seem to be changing. At the end of last week the Dow Jones skyrocketed up several hundred points. Instead of the dollar and oil decreasing and bond rates going down, the opposite happened. Crude oil has decreased slightly, the dollar has appreciated in value and bond rates have remained unchanged.
The Bernanke Files will be watching this turn of events very closely. While still in the early stages, these changes could signify growth, but also the emergence of inflation risks. The Bernanke Files will keep you updated on this trend as events unfold.
Sunday, August 9, 2009
What to Look for This Week
The Bernanke Files is reporting from beautiful Detroit, Michigan. Well, we're assuming its beautiful- we're actually stuck in the Detroit airport for a 3 hour delay.
Having some time on a Sunday evening, we thought it would be a good opportunity to take a look at the upcoming week. First, we take a look at where the Asian markets are at. Currently they (the Nikkei) are up 24.0 points. Few Americans are aware that the Asian markets open up in Japan in the morning (local time). This means they are open at about 3:00 pm MST. This early look gives us a preliminary look at what investors may have on their mind. Because the Asian markets are open, American markets open futures trading for most of their markets as well. For example, crude oil, corn, wheat, the Dow Jones Industrial Average and many other markets are open at night. These are called the "night markets."
After taking a brief look at the Asian and night markets, we take a look at the economic calender. The economic calender provides investors with the most important events occuring in the markets this week. Good economic calenders, such as the one provided by Bloomberg, also give users other helpful information such as what the concensus is and a brief description of what each event means.
This week, an important and interesting release occuring is the International Trade report. This gives us the earliest data on what America's net import/exports are. the concensus for this month is that the trade gap will be $25 billion. This is way down from last year because wer are importing a lot less goods because of the recession.
Keep in mind that the markets always beg the question: If a butterfly flaps its wings in China, what will occur in New York. The markets are closely intertwined. As you may notice, on Monday there are a lot T-Bill auctions. These results will tell us how much it cost for the government to borrow money. But, as The Bernanke Files has pointed out, the auctions and the International Trade report are linked. Remember, if Americans import more than they export, the cash that was used to buy the imports had to come from somewhere. Of course, one of the main places the funds come from is from T-Bond sales. This is why international trade and T-Bill sales are linked. Since foreign Americans need LESS money to make up the difference between imports and exports, foriegn exporting countries need to loan us LESS money to make up the difference. Therefore, demand for T-Bill will go DOWN and prices will drop AND THE INTEREST RATE WILL GO UP. These complex relationships between different sets of data make the markets very difficult to study.
Having some time on a Sunday evening, we thought it would be a good opportunity to take a look at the upcoming week. First, we take a look at where the Asian markets are at. Currently they (the Nikkei) are up 24.0 points. Few Americans are aware that the Asian markets open up in Japan in the morning (local time). This means they are open at about 3:00 pm MST. This early look gives us a preliminary look at what investors may have on their mind. Because the Asian markets are open, American markets open futures trading for most of their markets as well. For example, crude oil, corn, wheat, the Dow Jones Industrial Average and many other markets are open at night. These are called the "night markets."
After taking a brief look at the Asian and night markets, we take a look at the economic calender. The economic calender provides investors with the most important events occuring in the markets this week. Good economic calenders, such as the one provided by Bloomberg, also give users other helpful information such as what the concensus is and a brief description of what each event means.
This week, an important and interesting release occuring is the International Trade report. This gives us the earliest data on what America's net import/exports are. the concensus for this month is that the trade gap will be $25 billion. This is way down from last year because wer are importing a lot less goods because of the recession.
Keep in mind that the markets always beg the question: If a butterfly flaps its wings in China, what will occur in New York. The markets are closely intertwined. As you may notice, on Monday there are a lot T-Bill auctions. These results will tell us how much it cost for the government to borrow money. But, as The Bernanke Files has pointed out, the auctions and the International Trade report are linked. Remember, if Americans import more than they export, the cash that was used to buy the imports had to come from somewhere. Of course, one of the main places the funds come from is from T-Bond sales. This is why international trade and T-Bill sales are linked. Since foreign Americans need LESS money to make up the difference between imports and exports, foriegn exporting countries need to loan us LESS money to make up the difference. Therefore, demand for T-Bill will go DOWN and prices will drop AND THE INTEREST RATE WILL GO UP. These complex relationships between different sets of data make the markets very difficult to study.
Wednesday, August 5, 2009
The Future for Interest Rates
While The Bernanke Files never "looks into its crystal ball" and speculates about the future, we would like to discuss what economics ripples might occur when the we exit the recession. More specifically, this entry examines the effects on interest rates.
Currently interest rates are very low. The Fed discount window is at .25%, and 10-Year Treasury Bonds yield 3.71%. This tells us several things, but probably the most important thing it tells us that investors are very wary of starting new ventures. Since the yield is 3.71%, we know that an investor believes he CANNOT MAKE MORE THAN 3.71% outside of buying T-Bonds. While in reality this is too simple (the low interest rate includes a very high premium for the extreme safety it offers), this is a good place to start.
When the economy begins to turn around, these same investors will want to be taking advantage of a strengthened economy. Unfortunately, their money will be tied up in the T-Bond they purchased for, lets say, 8 more years. They have two option: keep the low yielding bond, or they can sell the bond for cash. If the investor chooses the latter, supply of bonds will go up and the interest rate will go up also!! (Remember, if supply goes up, than price goes down and the interest rate goes up).
It is at this inflection point (the point at which almost everybody with a T-Bond realizes investing is better than holding a low interest rate bond) that we will have to worry about another slowdown in the market because INVESTMENT will be stifled by higher interest rates. In other words, there will be a small window that interest rates will move between (the window between a very low interest rate and an interest rate that stifles investment).
If Congress runs too much of a fiscal deficit and has to borrow too much money (thus selling bonds), the enormous dropping of T-Bonds into the markets will make interest rates rise out of the window pushing us back into a recession.
At this point, though, foreign countries that export goods (China, India, Germany), will see a drop in exports because the USA slips back into a recession. They will reduce their employees wages by taking profit and purchasing T-Bonds. This LOWERS the interest rate in America and, because their is so much cash going into America, credit becomes easy and a bubble is created.
Of course this is an oversimplified model, but it shows how complex of a job economists have. Remember, this is almost exactly what happened from the 2001 recession through to the 2008 recession. It is interesting that while most people blame the Federal Reserve for easy money, they are curiously and I believe rightfully absent from the model. Easy money came from Congress fiscal irresponsibility, not the Federal Reserve keeping the discount window interest rates too low for a couple of quarters.
Currently interest rates are very low. The Fed discount window is at .25%, and 10-Year Treasury Bonds yield 3.71%. This tells us several things, but probably the most important thing it tells us that investors are very wary of starting new ventures. Since the yield is 3.71%, we know that an investor believes he CANNOT MAKE MORE THAN 3.71% outside of buying T-Bonds. While in reality this is too simple (the low interest rate includes a very high premium for the extreme safety it offers), this is a good place to start.
When the economy begins to turn around, these same investors will want to be taking advantage of a strengthened economy. Unfortunately, their money will be tied up in the T-Bond they purchased for, lets say, 8 more years. They have two option: keep the low yielding bond, or they can sell the bond for cash. If the investor chooses the latter, supply of bonds will go up and the interest rate will go up also!! (Remember, if supply goes up, than price goes down and the interest rate goes up).
It is at this inflection point (the point at which almost everybody with a T-Bond realizes investing is better than holding a low interest rate bond) that we will have to worry about another slowdown in the market because INVESTMENT will be stifled by higher interest rates. In other words, there will be a small window that interest rates will move between (the window between a very low interest rate and an interest rate that stifles investment).
If Congress runs too much of a fiscal deficit and has to borrow too much money (thus selling bonds), the enormous dropping of T-Bonds into the markets will make interest rates rise out of the window pushing us back into a recession.
At this point, though, foreign countries that export goods (China, India, Germany), will see a drop in exports because the USA slips back into a recession. They will reduce their employees wages by taking profit and purchasing T-Bonds. This LOWERS the interest rate in America and, because their is so much cash going into America, credit becomes easy and a bubble is created.
Of course this is an oversimplified model, but it shows how complex of a job economists have. Remember, this is almost exactly what happened from the 2001 recession through to the 2008 recession. It is interesting that while most people blame the Federal Reserve for easy money, they are curiously and I believe rightfully absent from the model. Easy money came from Congress fiscal irresponsibility, not the Federal Reserve keeping the discount window interest rates too low for a couple of quarters.
Sunday, August 2, 2009
An Economics Riddle
Here are a couple of economics riddles.
An American buys a product from Wal-Mart that was made in China. Wal-Mart charged the American $1. How much of the $1 do the Chinese actually get?
In an unspecified time period, American's buys $2000 of goods from China. In that same amount of time, China buys $500 of goods from America. Where does the difference of $1500 go?
Hint: The answers are in percents, eg: 10% goes to fixing Chinese manufacturing machines.
An American buys a product from Wal-Mart that was made in China. Wal-Mart charged the American $1. How much of the $1 do the Chinese actually get?
In an unspecified time period, American's buys $2000 of goods from China. In that same amount of time, China buys $500 of goods from America. Where does the difference of $1500 go?
Hint: The answers are in percents, eg: 10% goes to fixing Chinese manufacturing machines.
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