Why the Fed shouldn’t have cut interest rates
by Joseph P. Reidy, partner, Maurice F. Reidy & Co.
November 2007 - The recent cutting of the interest rate by half a percent sends all the wrong signals to the American markets. The euphoria with which the announcement was received more nearly resembles the joy with which turkeys welcome Christmas, albeit, Christmas will be a little late this year.
Reducing interest rates may have a positive effect on employment, but it will not help the housing market in the long term. US mortgages, unlike those in, for example, the UK, are fixed for long terms. Those people who are in trouble will still be in trouble. Those on the brink of trouble will not be saved by the half-percent cut.
Lower rates will, once again, remove the incentive to save and encourage spending to drive a debt-ridden lifestyle and extends its appeal to even more people. The markets love this, because the interest of the markets is only short term. Very few people on Wall Street can even think clearly to the next quarter, let alone beyond it.
However, all the statistics are there to see: record borrowing on a personal and federal level; rising mortgage defaults; rising personal debt. Moreover, the funding that is driving the lending and the buying isn’t being raised from within the US, it’s coming from foreign sources. While not ideal, this in itself isn’t bad. What is bad is that the cash being imported is being spent on goods that are also imported, and not bolstering America’s wealth generating capabilities.
For all the billions of dollars being borrowed from abroad, the US wealth-generating infrastructure is benefiting very little. Strong retail and service sectors require a strong wealth-creating base to fund them. American manufacturing is about the same size (in terms of jobs and value) as it was in 1940, but it has shrunk dramatically in terms of its size in relation to the rest of the economy.
Government funded (in reality, Chinese-government funded) maga-projects are not enough to keep the US economy healthy. There is a need for a realignment of values that begins not to question why a cup of coffee costs four bucks, but why people are willing to pay four bucks for it.
To some extent, there is not much new here. These cycles have happened before. The trouble is that people have forgotten that it has happened, and what made it happen. The elevator comes down as well as going up, and planning to finance property on its future value is as speculative as any investment gets. Health warnings about past and futures performance on documents have had about as much effect as cigarette heath warnings had in the 1960s, 70s and 80s.
Only when a lot more people had died did the message start to get through.
Only when a lot more people lose their jobs and their homes will the economic message begin to get through.
Economics 101 is very clear about situations like this: save more; spend less; adjust your expectations and tailor your aspirations until you can afford them. If you can’t afford the best, find the best value.
But, what hope have ordinary people got when the Fed hasn’t got the message yet?