Wednesday, December 02, 2009

Lending to ourselves

To make us look richer.

Those who stop by here that have a real understanding of economics should understand that nothing I post here in economics is prophetic or guinious. What I do here is distill some of the important news of recent times, and flavor it with my own philosophy. Nothing more. My goal is simply to make it understandable to the average Joe.

The numbers used by Wall Street and the govnernment show the economy is truning around, but this is partially an illusion, due to the decline in the value of the dollar.

The biggest recent news, for me, is the slide in the 5 year bond rate, from the boring little dance it did around 2.3% from last spring until this fall. It is now around 2.05%, and I saw 2.00% for a monment last week. The surface reason for this drop in intrest rates is the banking crisis in Dubai. The underlying reson, and the reason it has been staying so low for so long, (remember, a few months ago I said it was formerly 2.9%) is a stealth economy growing in the Washington-Wall Street circles. Seems the Fed has been buying up long term bonds, both government and corporate bonds and securities.

Keeping in mind that the Fed is loaning money to banks
and some other financial institutions at .1% (yest that is one tenth of one percent) this amounts to flooding the markets with free cash. And who is buying up this free cash? Well, it seems the banks are. It seems that, while Washington is publicly telling the banks to loan to homeowners and small businesses, it is quietly structureing the rules so that banks will invest in something safer. Like US treasury bonds. Yes you read that right. The Fed is lending to banks at near zero interest, and the banks are turning around and investing that money in the Fed at 2% to 4%. Free money for banks.

Brave New World
This has sparked a new era of "the dollar carry trade." The term is new, so you might have better luck looking up "yen carry trade" which was a phenomenon in the 90's. Meanwhile, many paniced investers all across the globe (including the coountry of India) are buying up tons of Gold. Not for the first time, the US Mint is short on one once gold coins. While I don't think this is the end of the world in any since, this with what I wrote about the past couple of months, does foretell a new era of increased hardship for the American worker.


Anonymous said...

Gonna expose the level of my economic ignorance here but have questions.

Any thoughts on how our sinking dollar will affect China and our economic relationship with her.

If China had no faith in our dollar could she secretly call in our debt and negotiate a reduced settlement with us?

The Fed is feeding banks to absorb more coming losses as opposed to righting the economy?

Bankers know better than anyone the effects of a hyper inflated dollar. Would it be wise to spend while the dollar still has buying power. What could banks be looking to invest in. Something in their field of expertise like foreign or a global currency?


TRex said...

Not really so ignorant. At least you know enough to ask, instead of just going on down the road without knowing.

Our shrinking dollar is making China nervous. She is actually quite concerned because if, for instance she owns $800B of our debt, and we deflate the dollar to half by printing a lot of money, she will only get $440B back. The same as if we negociated for a reduced settlement. And she would just have to eat the loss.

The Fed is indeed (quietly) feeding banks, by continuing to give them interest free money. Doing this as opposed to righting the economy? Well, maybe as a smokescreen. They are incapable of righting the economy, but doing this may be payback for some of the favors that got them into office. Or not. I don't really know. Mainly, they have to be seen doing SOMETHING, even if it is the wrong thing.

Well, this is no time to have cash under your matress. I wouldn't spend like a drunken sailor either. There will be a round of inflation, although it looks like it may get put off until 2011 or so (and until then, we will have high unemployment). But not hyperinflation. I say if you need tools for your trade, don't put off buying them. If you can make good sound investments, go for it. It looks like the one window for buying gold came and went at the end of 2007. Right now have bougt some tools, and that truck I bought when mine died has pretty much tapped me out.

Anonymous said...

Funny you should mention tools. Just bought pretty much a second set. Thinking the same as you.

One more question. When we sell debt is their no clause to account for inflation? I mean inflataion is a given even in good times..


TRex said...

Any time money is borrowed, or loaned (same as buying debt) inflation is supposed to be built into the interest.

Hence, if you loan someone money and you think there will be 4% inflation, you should charge interest to cover that, any interest above that is your profit.

Seeing the 10 year bond rate at 3.4% means the majority of those buying bonds think the average inflation rate will stay below 2.4% for the next 10 years.

I think they are wrong, but the alternative is that the economy will stagnate (high unemployment) for most of that time. I will discuss this more in my next economics article.

dw said...

I was thinking. 9/11 had serious consequences to our economy. Never hear anyone link it to what we are seeing today. Scares to think that Muslims are that smart and we that stupid. I said 'Muslims' as opposed to 'radical Muslims' on purpose.


dw said...

Am I wrong is thinking that financial institutiions have every interest in a growing interest rate?


TRex said...

Muslims are not that smart - directly. The attack was aimed at immediate goals of mass casualties and fear. In the long run, though, they are every bit as smart as you think. Witness the Muslim Brotherhood and the 100 year plan. We can't even stay on a 5 year plan.

Banks make their money from outrageous fees and the difference in interest they can charge compared to what they have to pay to get money. The competition between them keeps them in line, somewhat, which is why having several banks is preferable to a couple that are "too big to fail." As long as interest rates do not go up or down SUDDENLY, the banks will always make money.