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Tuesday, September 18, 2007

Fed Cuts 50

OK, the Fed did cut the 50 bps. I think it was necessary for the reasons I explained here, and many others disagree and make strong arguments to that effect. We'll have to wait a few weeks to see even short term effects that matter in credit markets, although obviously the Dow threw a party. The effects on treasuries were much less notable. Check out treasury yields, and tell me if it looks like much happened today? The significant effect were on the 3 month through 1 year, not anything further out.

I don't often write about other countries, because the one you can usually help or hurt is your own. But check out this column on Japan's public debt:
The idea that the second-biggest economy would default on debt is almost unthinkable. Yet ratings upgrades are rewards for good fiscal deeds, not continued profligacy.

Even though Japan has enjoyed steady growth since 2002, it has made no noticeable progress in reducing public debt. Officially, it hovers at about 150 percent of gross domestic product; observers such as the Organization for Economic Cooperation and Development put it at around 170 percent.
In comparison, the US has public debt amounting to less than 70% of GDP (according to the CIA). It may sound odd to American ears, but the most important likely effect of today's rate cut might be to stimulate the Japanese economy. If the world wants to escape real economic misery, it needs at least one of the two to get a grip and forge ahead, and Japan's GDP contracted in the second quarter. The Chinese and Indians are getting there, but are simply not able to consume all that much.

I don't have a crystal ball and no one else does either, but all hopeful theories about decoupling really depend on Japan doing well and the EU doing well, and unfortunately the IMF cut the European 2008 growth rate prediction back to 2.3 when it cut ours to 2.2, and cut Germany's back to 2.2. This is not what anyone wanted to hear, but it is important background for the Penner comments.

Wikipedia has a nice list of country rankings by GDP.


OK, so now that the moment has come and gone and we know it's 50 bps (good call), what will you be looking for to see if conditions are improving?

For example, in a previous post, you spoke about good companies having their loans called back in because the bank needed to cover other bad loans. Besides your contacts, are there more general indicators you will be looking at?

And if Fed rate cuts take 6-18 months to work through the system, is it your sense that today's move is likely to only make a bad situation not quite as bad ("help forestall some of the adverse effects on the broader economy"), or do you think the psychological impact might help us to avoid a significant amount of disruption?

I hope you can see what I'm getting at. I'm not asking you to predict the future. I'm just curious what you're thinking now after having a couple of hours to digest this news.

Thanks for your blog.
If a recovery in the housing market is defined as a reasonably normal number of transactions only,then I think we are likely 2-3 years or more away from that in california.Prices must return to affordable levels,and The market for single family homes is influenced by psychological factors more than most markets.When I look at demographic and economic factors and probabilities for california,and the types and locations of the recently built homes...I see long term demand for closer in,smaller homes suitable for an aging population.I do not expect to see prices like this for homes again in my or my 6 year old childs lifetime,adjusted for inflation of course. a $20k cup of coffee is not completely out of the question in he next decade.
MOM, can you flesh out your reasoning as to why the rate cut here might provide stimulus to the Japanese economy? Thanks.
Tom - I agree largely. I don't see any chance of recovery before 2010.

Mthood, I'll be watching areas like NC to see if at least conditions seem to be stabilizing. Last year I looked around the country for the best mixed, least bubbly areas I could find. I said to myself that when they started slumping perceptibly, I'd know a recession had started. They all rolled over this summer. I am not expecting miracles, but if they could stop going downward, that would be a big bonus. It will be two-three months before anyone could hope to know at the earliest.

Also the relation of mortgage rates to treasuries, whether the treasuries can break out of the camel graph, if things seem to be easing on small commercial, and watching the commercial paper very carefully. It's really the commercial loans that are the threat. NACM publishes its own credit survey, and I will look at that for probably the earliest signs of hope. Again, two to three months. Freight, of course. November retail sales will be a good indicator, but of course we won't get those for quite a while.

I don't believe this will be nearly enough to offset the headwinds and the drag, but the question is how much response will we see?

There will be at least a short-term psychological benefit on the stock market, but after about six weeks it will depend on the news as to whether that continues.
Napolean, how's Josephine?

I think Japan is in a crisis of confidence and I hope this move will alleviate it. Part of the problem is the pensions, part the political instability, and part what seems to be a retraction in business investment by Japanese mfrs who are probably trying to build capital. I think they are just afraid of the effects of the property bubble elsewhere after what has happened in Japan. The Nikkei is certainly responding tonight!

Stats like the 7.4% YoY domestic drop in machine tool orders in Japan for August are a concern. Their foreign orders did increase by I think 34%? The US is a very large auto market for Japan, so naturally slumping US auto sales would be an issue.

Machine tools had a rough spring and then exports picked back up, which matches somewhat with the better mfrg report in the US. Cheaper interest rates would tend to help investment in the US, which would be favorable to the Japanese.

This is a very important industry for Japan. I think in 2004 about 20% of all their exports were to the US. In any case, if domestic machine tool orders continue to decline, it will be a sign of declining business investment in Japan. The Q2 contraction in Japanese GDP was probably highly related to the machine tool orders.

Is there a safe haven in a recession? Do you expect a worldwide crash like I've seen some predicting?

It seems that there is a psychological threshold that's been crossed. Americans are jittery that the Brits are lining up at the banks. Should a similar phenomenon happen here, where do people invest? The underside of their mattress?

And do you think there is a gold bubble or is gold a solid investment given the potential for inflation?
Dr. M, I've just never been able to get enthusiastic about gold. It's inert. It does nothing.

If we have a worldwide crash, inflation will not be a problem. I think most people would be better off maximizing their income potential and making sure their debt is well under control and minimized in relation to their income.

It's not so much a psychological barrier that's been crossed as a bubble of plausible deniability that's been punctured. The reality is that everyone's been pretending that people and companies will be able to pay debts that they are not going to be able to repay. In short, it's not nerves, but sobriety and the cold clear light of morning.

I wouldn't panic too much. Companies that are in a good position as to cash flow/debt ratios and produce things that people need will probably do well, and their stock is worth keeping for the long term. It's likely that by next year companies will be trying to pay out higher dividends, for one thing.

There is structural worldwide inflation for goods everyone wants and needs, and there is also widespread speculation driving up the cost of some of these commodities. What one would expect is that a weaker dollar would continue to stimulate US manufacturing.
MOM, I think you are thinking of NapoleOn. I am NapoleAn, the American spelling of the name.

RE: Japan, certainly if the rate cuts help the US economy avoid a recession, I can see how that would really help Japan's US exports. Even if the cuts just moderate a recession, that too would provide some relief.

But if Japan's success depends on US exports, I think they may want to temper their economic outlook. I dont see how the US consumer can continue to spend like they have the last few years without MEW
Napolean, I was just teasing. Yes, you are right that Japan has reason to worry. Mitigation of that worry is about all we are going to get. Mitigation is a good thing!
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