Real Interest Rate = Nominal Interest Rate - Rate of InflationThis approximation is accurate enough for casual discussion.
The Hungarians have always been considered shopaholics. Hundreds of thousands bought themselves big cars and went on shopping sprees in the chic boutiques on Váci Utca in Budapest -- all on credit. The real estate market boomed, turning close to 90 percent of Hungarian apartments are privately owned. Most mortgage loans were denominated in euros and Swiss francs. But that practice has taken its toll. As the Hungarian forint plunges in value, mortgage holders are suddenly paying astronomical interest rates. It was primarily this dependency on other countries that has fueled the crisis in Hungary. Ironically, Budapest was once seen as a role model for other countries seeking EU membership. But instead of following in the footsteps of the Czech Republic and Slovakia, and introducing structural reforms after the collapse of communism, the Hungarians kept growing their national debt. A few days before the runoff vote in the 2002 parliamentary election, the conservative government of then Prime Minister Viktor Orban increased pensions by a substantial amount. Orban's successor, Peter Medgyessy, a socialist, introduced a 50 percent salary hike for teachers and healthcare workers.It is not explicit that the loans were from foreign banks, but the effect was the same: they were denominated in foreign currency.
call some silicon valley visionary (paging Steve Jobs)Barf. LOL.
On the edge of the known financial universe lies the planet Zirp, where money appears to be free. Zirpeans explain...but, really:
The economy was so weak that deflation reigned. Nervous banks, firms and households – quite rationally – clung to cash rather than spend or lend it. Deflation meant it was worth more each day. The same, unfortunately, was true of debts. As a result, everyone scrambled to pay off their mortgages, credit card balances and the like. Credit demand collapsed. Not even zero interest rates could get the economy moving. Nobody wanted to borrow.
Everyone naturally wants to avoid this scary state of affairs. Yet Zirp, in itself, is nothing to be afraid of. What is scary is deflation. Falling prices meant Japan’s zero interest rate was actually positive in real terms. Rates only appeared to be zero because of what economists call the “money illusion”. Money, in fact, was not free. That was the problem.
That is why central bankers have cut rates so fast this past month. They want to pre-empt the need to go to Zirp by flooding the world with money. US and UK rates are negative in real terms... So is the global economy headed towards zero interest rates? The answer is that, in real terms, it has already arrived.
"...the target itself has become largely irrelevant as an instrument of monetary policy, and discussions of 'will the Fed cut further' and the 'zero interest rate lower bound' are off the mark. There's surely no benefit whatever to trying to achieve an even lower value for the effective fed funds rate."What is a Depression?
Policy traction comes from the balance sheet at this point. Balance sheet related actions have focused on ungluing the financial markets – actions that have been critical in preventing the system from collapsing by replacing lost liquidity, but have so far be insufficient in preventing recession. The Fed is simply cushioning the deleveraging underway. Hamilton suggests moving to the next stage in the game:
"...I would urge the Fed to be buying outstanding long-term U.S. Treasuries and short-term foreign securities outright in unsterilized purchases, with the goal of achieving an expansion of currency held by the public, depreciation of the currency, and arresting the commodity price declines."
One only has to read a few of Fed Chairman Ben Bernanke’s past speeches to known that some variation of this option is on his mind. Still, I think the Fed will opt to pass the baton to fiscal authorities before shifting to a policy of unsterilized asset purchases.
The push for a rapid fiscal response is building, including an effort to pass at least one measure during the upcoming lame duck session of Congress. The main event, however, will not be until next year, and the resulting package will be significant. A final price tag of $500 billion would not surprise me (can’t let ourselves be outdone by the Chinese), and will hopefully include a wide array of elements currently on the table; for example, extending unemployment benefits, aid to state and local governments, some tax cuts, and infrastructure spending.
How much bad policy will be included? There will always be some bad policy, even in a more enlightened administration. For a change, the good should vastly outweigh the bad. Still, how many more blank checks will be handed out, such as the one to AIG? How many more industries will come begging at the government’s door? Automakers are almost certainly going to get their piece of the pie. And, most importantly, will the focus of policy be supporting and cushioning the transition from a consumer/debt supportive growth dynamic, or preventing/reversing the adjustment already under way?
The US economy is restructuring; I suspect the process will be lengthy, and that patterns of growth on the other side will be very different... The US has spent the better part of 20 year favoring nontradable sectors over tradable sectors, ultimately pushing the nation to focus on the production of overpriced housing and financial services (the latter arguably tradable, but no longer in demand). Reversing these patterns will not happen overnight – a period of structural unemployment is almost certain. Preventing this process (by, for example, pretending that we can fix the economy by fixing housing prices) would be misguided. But...
...the “bust phase” may involve the Central bank loosening rates to aid the economy as a whole. As I have explained before, the Fed loosening monetary policy only stimulates parts of the economy that can absorb more debt. Those parts with high yield spreads because of the bust do not get any benefit.i think it's going to involve some sort of central planning and volunteerism (non-market & decentralised - srsly!) + rethinking what money itself ought to be :P
But what if there are few or no areas of the economy that can absorb more debt, including the financial sector? That is a depression... We face a challenge as great, or greater than that at the Great Depression, because the level of debt is higher... We are in uncharted waters, held together only because the US Dollar is the global reserve currency, and there is nothing that can replace it for now... But eventually this will pass, and foreign creditors will find something that is a better store of value than US Dollars. The proper investment actions here depend on what Government policy will be. Will they inflate away the problem? Raise taxes dramatically? Default internally? Externally? Both?
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posted by diogenes at 3:45 AM on November 12, 2008 [8 favorites]