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An update on the US economy

August 28th, 2010 | Author:

Since global financial issues are important to New Zealand, it is important to keep tabs on the largest economy of them all in the United States.  One of the world’s wealthiest companies is the US Federal Reserve (no it is not Government owned like in New Zealand, Australia, United Kingdom and the vast majority of other countries).  Their chairman Ben Bernanke has huge responsibilities and has the unenviable challenge to try to resurrect the ailing US economy.  This cannot be an easy task and it must be hard for Americans to stomach the fact that it is not if but when they will be overtaken by China as the largest economy in the world.  Earlier this month China overtook Japan as the second largest economy in the world.

Ben Bernanke - US Federal Reserve Chairman

Last month Ben Bernanke told a congressional committee that the economy was “unusually uncertain”, however importantly he did not predict that it would fall back into recession.  Who am I to argue against Ben Bernanke on the US economy – so I am not panicking and can’t recommend that you sell your assets know.  Far from it, as there are some very good opportunities to those who have the cash to buy them.  I have seen a mentoring student purchase a commercial property at half of its CV on a vacant property, and another student buy a residential rental property at $200,000 below its CV (just over 30% below value its independent registered valuation), and there are some exciting businesses to purchase shares in with different degrees of volatility.

Then earlier this month the US Federal Reserve said it would use the proceeds from its own investments in various mortgage securities to buy longer-term US Government Treasuries.  As a result significant amounts of money will be pumped in to bolster the US economy and companies like Apple and General Electric will continue to enlarge their already massive treasure chests.

Bernanke’s four options for the US economy

At the annual Jackson Hole (Wyoming) symposium yesterday with central bankers, Bernanke said the recovery had slowed to “a pace somewhat weaker” than forecast.  He said that there are four “unconventional” options for the kickstarting of growth in the US economy.  With the US June quarter GDP growth at just 1.6%, a worsening balance of trade position, and continued high unemployment statistics, it appears that there will be a long hard road to recovery over the next couple of years for the United States of America.

Policy Option Pro Con
1. Quantatitive easing (buying up debts). Worked during the crisis. Holds down long-term borrowing costs. Hard to quantify effect, and may be less effective when markets are not under stress. Markets may worry about whether the Fed can safely exit its investments. Inflation risk.
2. Communication (promising to keep rates low for longer, or until certain conditions are met). Should lower longer term interest rates. Promises cannot be binding, and conditions for raising rates may be hard to pin down.
3. Paying zero interest on banks’ excess reserves at the Fed. Interest rate cuts are well understood. The effect on borrowing costs would be small (0.1%-0.15%). A zero rate could undermine the functioning of money markets.
4. Targetting a higher inflation rate. Could help reverse a prolonged period of deflation (falling prices) like in Japan. Not popular at the Fed. Makes inflation expectations more uncertain. US is not in deflation, and the risk is rather low.

What option or combination is yet to be seen.  The monetary policy intervention will continue and it has to.  Lets hope the US can recover and that this will spread onto Europe, which is not in great shape either.  As a global financial markets are facing challenging times.  There may be a positive spin-off to this bad news, if you are a borrower in New Zealand in terms of lower interest rates.  It is likely that the US medium and long term swap rates will stay at their current low rates for a significant period of time.

Posted in General, Interest Rates & Loans, Market Commentary

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