Great question. The Fed doesn’t care if homeowners lose equity or end up in foreclosure. The links are in one of my other posts. The Fed is concerned with the economy as a whole, with the national numbers. They’ll only intervene if the calamity causes risk to the financial system. The Fed has wiped their hands clean of any involvement in asset bubbles, by claiming they cannot predict them anyway.
The questions is: don’t they know that when the housing bubble collapses, it can take the economy down with it?
I’m still trying to figure out where to put my money. So much is unknown. Will China stop buying our debt? How long will the consumer stay strong? How will the Fed react to the data they use for their monetary decisions? How will the economy react to the Fed’s policies? Nobody knows how any of this will play out. Guessing is all we can do.
Diversification is the least risky bet. You won’t lose all your money at least. Bet all your money on one thing, like gold, and you’ll lose it all when gold goes down. Put it all in a CD, and you lose value if inflation picks up.
It makes sense that commodities (think lumber, cement, lead, sugar, coffee, metals, oil) which have a great supply lag due to lag of popularity in recent years, are poised for their bull market. Each asset has a cycle, and the commodity boom which began 8 years ago still has some life left?
It makes sense to diversity into different currencies (yuan, euro, swiss francs), as Warren Buffett did. What I really like about him, besides his intelligence and wisdom, is that he is a straight shooter. He bet billions of dollars against the USD by hedging against it. Last year this caused him to lose a billion $s, or so, as he was early in his bet. It makes sense to hold some equity in Berkshire Hathaway (the B shares are under $3K each), and let the oracle of Omaha do the investing for you.
I believe the Fed is flooding the system with dollars, as well as defending the dollar, but not for the reasons you suggest. The Fed doesn’t care if Susie Q loses her home, only that she might stop shopping to stimulate the economy.
The Fed is flooding the system with dollars, because the government needs more money to pay for the entitlements, military spending (we’re in 100 countries!), the interest on our national debt, and the trade deficit. The only way to pay for it all is to keep injecting money into the system. If one of the big banks does fail, or Fannie Mae needs a taxpayer bailout, there will be another huge injection of money. I believe it’s done electronically now, so there is no real printing of money to increase the money supply.
The Fed needs to keep the dollar’s value high, to keep foreigners buying the dollar. By setting short-term rates high, they hope that long-term rates follow along (which they haven’t always done lately). Imagine if the Fed lowered the interest rate back to 1%. Now that Japan and Europe have raised their rates (somewhere above 2%?), China could just go buy euros or yen, and if they stop buying our 10-yr and 30-yr bonds. Then who will finance our debt? The Fed may also be concerned about the recent interest in gold. Gold buying is higher than can just be accounted for by jewelry and industrial demand. Investors are fleeing to precious metals because they feel insecure about the dollar. The Fed must stop that rush to the exits.
The Fed is also concerned about inflation, or so they say. Assuming that real inflation is 8%, and not the 2% they claim, they have more reason to be concerned than they let on. Commodity prices, esp. oil have really inched up, and will just keep going higher. Oil production is at peak capacity, oil field production is waning every year, and demand from China is growing rapidly. This supply-demand imbalance will keep growing, and oil has nowhere to go but way up. Again, this will cause inflationary pressures, because oil is essential in making products, running industrial machinery, in farming (fertilizers, operating tractors), transporting goods across the country, for the health of the airline and auto industry. As commodity prices rise, eventually the cost is passed on in goods and services, increasing inflation. (Of course, rising oil prices are not reflected in the CPI, so it doesn’t matter to the Feds that Americans are squeezed by high heating costs and gas bills.) So to reduce inflation, they must keep raising interest rates.
Is there a reason to think that interest rates could go to 6%, 7%, 8%? Why not? I think the important indicators, such as commodity prices, and FCB purchases of our bonds, will determine how high they must go.
