Americans must bring down the trade deficit or risk crippling
their economy through a run on the dollar and credit crisis, but trade
with China and oil each account for more than 40 percent of the trade
deficit.
Peter Morici's recent piece looks at the credit, interest rate,
trade deficit and energy relationships after the jump. (read
more).
****
The Limits of Federal Reserve Policy
Peter Morici
Federal Reserve policymakers and critics labor under false assumptions.
Hawks believe tighter credit can stave off inflation. Doves hew to
lower rates to mitigate risks of recession.
Rocketing oil prices may accelerate inflation, while the credit and
housing crises, and the still huge trade deficit threaten recession.
However, these cannot be countered adequately by modulating interest
rates.
China and India are growing ten percent a year, causing global oil
demand to outrun supply and pushing prices to near $100 a barrel.
The United States consumes only one quarter of the world’s oil, and
accounts for a smaller share of growth in demand. Trimming U.S. GDP by
one or two percentage points, with tight credit, would slice an
inconsequential fraction off global oil consumption, and little affect
broader U.S. inflation. Yet, the drag of tight credit and higher gas
prices on consumer purchases, together, could sink the U.S. economy.
The grip of foreign oil can be relieved only by higher auto mileage
standards and tougher conservation measures than Congress is
considering, and by further developing domestic petroleum, nuclear and
alternative energy sources. Neither political party has demonstrated
the courage to ask Americans to do what is possible and necessary.
Over the next 18 months, two million adjustable rate mortgages (ARMs)
will reset to higher interest rates, and many homeowners cannot afford
the payments. Without viable refinancing options, many homes will go on
the market, and the recent decline in home prices could become a route.
The negative consequences for consumer spending and unemployment are
obvious.
Federal Reserve Chairman Ben Bernanke is encouraging financial
institutions to exercise forbearance in restructuring ARMs but many
cannot be reworked because of the covenants in mortgage-backed bonds.
These loans must be refinanced but new loans cannot be written, because
the market for mortgage-backed bonds has evaporated.
Investment banks that bundle mortgages into bonds get higher interest
rates and larger profits when bond rating agencies conservatively
estimate risks of default. These investment banks, not investors, hire
and pay rating agencies creating ruinous conflicts of interest.
Standard and Poor’s and other agencies apply faulty methods to assess
risks of default, and assign overly optimistic ratings to bonds.
Investors who purchased these bonds have suffered large losses, no
longer trust the agencies, and won’t buy new mortgage-backed bonds.
Until bond rating agencies are forced to answer for their insidious
behavior, return to a system of investor-financed ratings, and adopt
credible methods for estimating risk, pension funds, insurance
companies and ordinary investors would be reckless to purchase
mortgage-backed securities. Without those investors, the funds to
refinance ARMs, and mortgages for many other worthy home buyers, simply
will not be available.
Lower interest rates would help avert some foreclosures, but cleaning
up the bond rating agencies and other problems in bond underwriting is
more essential to resuscitating the housing market.
Since the end of 2001, the annual trade deficit has increase from $353
to $713 billion, requiring massive borrowing from foreign private
investors and governments. Much of those funds go into U.S. government
bonds and other interest-bearing securities, keeping down the U.S.
mortgage interest rates.
Foreigners are becoming impatient with reckless U.S. economic
management, as witnessed by the recent drop of the dollar against the
euro. Foreign nervousness could jack up the cost of foreign funds and
U.S. mortgage rates. That would put more downward pressure on housing
prices, further increasing the risk of recession.
Americans must bring down the trade deficit or risk crippling their
economy through a run on the dollar and credit crisis, but trade with
China and oil each account for more than 40 percent of the trade
deficit.
China has insistently kept its currency undervalued against the dollar,
to keep its exports cheap on U.S. store shelves. Without a significant
revaluation of the yuan or American policies to counteract China’s
currency policies, China will have to purchase ever large amounts of
U.S. debt or Washington and Beijing will cope with a severe U.S.
recession.
The Congress and President have been willing to do little more than
talk with China about these problems, leaving U.S. credit policy
increasingly in Beijing’s hands.
Sooner or later, Congress has must confront the problems it does not
want to genuinely address: energy, Wall Street corruption, and trade
with China.
Until it does, Mr. Bernanke’s capacity to manage the economy with the
traditional tools of monetary policy will be quite limited.
Peter Morici is a professor at the University of Maryland School of
Business and former Chief Economist at the U.S. International Trade
Commission.
Peter Morici
Professor
Robert H. Smith School of Business
University of Maryland
College Park, MD 20742-1815
703 549 4338
Cell 703 618 4338
This e-mail address is being protected from spam bots, you need JavaScript enabled to view it
http://www.smith.umd.edu/lbpp/faculty/morici.html
http://www.smith.umd.edu/faculty/pmorici/cv_pmorici.htm
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