The Fed hit the markets with a half-point rate cut. The S&P shot up more than any time since the invasion of Iraq in March ’03. And now we read in the paper that Goldman’s (NYSE:GS) earnings in the last quarter rose 79%…and Abu Dhabi sank US$18 billion into giant buyout firm Carlyle.
Investors must think that the Fed’s intervention in the credit markets will be as effective as the Bush Administration’s intervention in Mesopotamia. And they’re probably right! In neither case does a campaign of shock and awe bring guaranteed results. Some problems just don’t lend themselves to meddling from outsiders.
In the case of the US economy, the Fed’s rate cut offers borrowers more credit at lower cost. But it is not as if the US economy has been short of credit. Total credit in the United States rose from 150% of GDP in 1971, when the dollar was cut loose from gold, to about 340% of GDP today. That, dear reader, is a credit expansion! It is what has made the US economy what it is today…and it is why a cut in the Fed funds rate may not be as effective as investors hope.
The financial authorities are correct – what the US economy (and by extension, the world economy) needs is more spending. Spending is what makes the money world go ’round. But who’s got money to spend?
The rich, of course. The luxury market has been extremely profitable for many years. But reports coming in to our Markets and Money headquarters tell us that even the rich are becoming hesitant to part with cash. They’re waiting to see how their hedge funds do…or what happens to the US economy. Million-dollar houses are taking longer to sell, according to our sources. Other markets for the rich – watches, cars, boats – are not quite as sans soucis and extravagant as they were three months ago.
But the rich don’t need credit in order to spend. They have real money.
Unfortunately, it’s the not-so-rich that drive an economy; there are so many more of them. As long as credit is expanding, ordinary people have more money to throw around. Inevitably, they reach a point when they can’t go on. The people from whom they borrowed begin to ask for their money back. Bills mount up. Sooner or later, the debtor can’t make his monthly payments.
Then, when the Fed comes along and offers lower rates, he’s likely to think twice. He may want to borrow more money…but he can’t afford it.
“Housing costs push working class to the edge,” comes the headline from the Financial Times.
His real problem is not a lack of credit; it’s a lack of spending power. He doesn’t have enough income to continue borrowing. High housing costs, high energy costs, high food costs…what’s a poor working stiff to do?
“Ghost towns” is how the New York TIMES describes some new housing developments. While low rates lured consumers to buy houses they couldn’t afford…the buying lured builders to build them. Now they sit empty…waiting for the day when willing sellers once again can come to terms with able buyers.
For the moment, the buyers aren’t able to buy at present prices…and the sellers aren’t willing to drop prices to a level where they can. The housing market, unlike the wheat market, takes time to clear. Our guess is that the adjustment will take several years.
The dollar went down again yesterday. It is probably going to drop to US$1.50 to the euro within the next 12 months.
Markets and Money