2008 January 22 Tuesday
US Federal Reserve Freak Out On Interest Rates

We have to go back over 23 years for a similar rate cut.

"It's a once-in-a-generation event," Mark Zandi, chief economist at Moody's Economy.com, said. In recent years, the Fed has rarely acted between scheduled meetings of the committee, and almost always in increments of one-quarter or one-half point. It was the biggest single cut since October 1984.

You'll be able to tell your grandchildren "They don't make rate cuts the way they used to. Before the world Borg mind took over the economy things didn't use to be such smooth sailiing. Why I remember that big rate cut the US Federal Reserve made in January 2008. There's been nothing like it since except for the bigger one they made in response to the world depression that came later".

The Times of London argues that the Fed made its move due to the threat of a looming bond insurance market implosion.

Fears that America’s bond insurance market could implode triggered the US Federal Reserve’s biggest interest rate cut for more than a quarter of a century, Wall Street economists claimed yesterday.

Market analysts said that Wall Street had spent last week gradually realising the grave consequences of a major bond insurer defaulting on its commitments and attributed the surprise rate cut to averting such a crisis.

As soon as some bond insurer goes bust all of the bonds it has insured up to an A, AA, or AAA status have to get sold by institutions that are only allowed to own highly rated bonds. This will cause big bond price drops and more financial institutions to fail. There's a real fear of a domino effect. Um, shouldn't we have financial markets that are not built up like dominoes? I'm just asking.

Allan Sloan of Fortune thinks the Fed responded to what it perceives as a market panic.

Forget all those rational explanations about why foreign stocks markets, especially in Asia, have been melting down for two days. Despite what you've read, seen and heard, those declines weren't caused by fears of what a recession in the U.S. would do to the profits of companies whose stocks trade in places like India, China and Russia.

Rather, the meltdowns were flat-out market panics, where rationality gets tossed out the window as everyone tries to head for the door at once and gets trampled. Go-go markets, especially in Asia, had risen to ridiculous heights - they were going up because they were going up, and momentum fed on itself. Now, they're going down because they're going down, and momentum is feeding on itself again.

The fact that the Federal Reserve Board announced an emergency cut of 0.75 percent in short-term rates shows that the Fed thinks the problem is a market panic rather than economic fundamentals.

That is worrisome. Panics and the madness of the crowds are scarier than mere inflation or a correction of an over built sector of the economy. But maybe the panicking is rational. Maybe lots of financial institutions are in worse condition than we know so far. That's certainly been the trend of the last year.

Do you think this recession might catalyze a critical mass in the growing opposition to globalism? Some think so.

As the prospect of a U.S. recession overshadows a tense and drawn-out election campaign in the world's most emblematic market economy, a corrosive cocktail of factors is eating away at old certainties: Power is steadily leaking from West to East. Income inequalities are rising in rich countries.

And signs of a protectionist backlash are multiplying as worries about climate change, the rise of state-run investment funds and the bursting of the recent credit bubble give novel ammunition to those in the West who question free markets and clamor for more shelter from globalization.

What exactly will emerge when the dust settles is hard to predict, economists and executives say. But this much seems clear: With the frontier between state and market once again up for grabs, the era of easy globalization is over - and big government in one form or another is back.

"The pendulum between market and state is swinging back," Pascal Lamy, director general of the World Trade Organization, said by telephone before traveling to Davos. "The year 2008 is a crucial year that could end up setting the tone for some time to come. What we need is an ideological mutation without falling into the trap of protectionism."

I don't want a severe recession or depression. It is not clear to me, however, that all the central banks are as powerful and wise as they are supposed to be.

Did you notice my (at least till this point) total lack of mention of details of a certain Congressional and Presidential plan to stimulate the economy? That was intentional. I do not think it will matter at all.

Share |      By Randall Parker at 2008 January 22 09:26 PM  Economics Business Cycle

HellKaiserRyo said at January 23, 2008 1:01 AM:

I want to live long enough to see an AI declare the Brookings Institution obsolete and other economic think tanks.

kurt9 said at January 23, 2008 9:15 AM:

There won't be any protectionism. The low dollar is resulting in increased exports from the U.S. as well as a flood of equity investment into the U.S. Lots of small and medium sized U.S. manufacturing companies are being bought up by foreign investors. This is good for U.S. job growth. Also, foreign investors are buying into the large banks and investment firms such as Merrill Lynch, Morgan Stanley, and Citigroup. This is also a good thing.

U.S. exports are double what they were a year ago. I expect the trend to continue. The FIRE (finance, insurance, real estate) economy will indeed take a bath in the next few years. However, manufacturing will do OK.

The Chinese hold about $1 trillion in U.S. T-bills. The Japanese hold another $1 trillion in U.S. T-bills. No one in Washington D.C, is about to do anything to alienate these guys. The current talk of protectionism is no different than the same rhetoric I heard in '89-90 (while I was at Thunderbird). It is nothing but bluster.

kurt9 said at January 23, 2008 9:24 AM:

The central bank (FED) created the problem in the first place with artificially high money supply in the late 90's, which created the equity bubble. When the equity bubble collapsed in 2000-2001, all of the money flooded into real estate, which was further fuelled with artificially cheap money by the FED. The equity bubble of the late 90's was never corrected for, which is why we may have a nasty recession this time.

Also, the FED (under Greenspan) redefined the CPI several times starting in 1993 with "hedonic" factors and "substitution" factors with the result of unreported inflation (which is around 2-3% per year).

The reason why big government and central banks cannot do anything to solve the problem (and why they make things worse) is because of the nature of large institutions. All large institutions are inherently bureaucratic (this is a law of nature, based on human nature). Bureaucracy in not capable of positive achievement. Again, this is based on human nature as well. So, anyone who thinks that any human problem, whatsoever, can be solved by bureaucracy is engaging in delusion. This is the reason why protectionism, big government, or more control by central banks cannot work.

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