Market excesses correct and revert to the mean, sometimes overswinging. The NASDAQ was at 6000, and is today at about 2000. It was wildly overpriced, and is probably at equilibrium today. When will it reach 6000 again? I believe in markets correcting to equilibrium, because that is what history has shown always happens.
The lower interest rates created a liquidity glut, because they were below inflation. Inflation was 3-6%, but interest rates were 1%. Why would anyone save money? Just borrow and spend.
I started working and investing in 1988, so I didn’t follow the 1990 recession. The last recession was a mild one, in 2000-2001. It was due to a decline in capital spending. But consumer spending stayed strong, thus it was a mild recession. Nonetheless, it spooked stock markets around the world, and stocks and commodities sank as capital spending declined.
Why did the Fed let rates go so low? I am not smart enough to know this. There are many guesses. I’ve read to avoid deflation. To avoid a recession after the dot com collapse and the terrorist attacks.
What the Fed knows and what they say are two different things. I spoke with my smart friend this morning (who wants to remain anonymous here), and he said that the reason the Fed is raising interest rates is to stamp out the housing lending bubble. Since the exotic lending was tied to the LIBOR and other short term rates, they needed to raise the short term rate. This is working.
Another problem is that inflation is rising globally. I don’t understand why it is rising now, and not before. I have a question why did it wait so long to rise. But the fact is that many central banks are raising interest rates to reduce inflation caused by rising input prices. In the 70’s our inflation was caused by rising wages. This inflation is caused by high prices in oil, commodities, and rents. What is not showing up in the CPI is contributing even more to inflation: food, health care, housing costs, insurance, tuition. If you put a real basket of consumer goods into the CPI (instead of doing hedonic adjustments and substituting rents for housing prices), you’d see inflation has been closer to 6-9%.
Bernanke talks about the importance of keeping expectations of inflation low. Inflation gets a foothold only if people expect inflation to be a reality. So you have to dampen the perception of it existing. They didn’t care about high inflation, until it showed up in the CPI. Now the Fed must keep raising interest rates until the CPI is in a comfortable range of under 2%, so that we all believe it is low, and act accordingly. So the Fed must keep raising interest rates as long as the CPI is above 2% (Bernanke’s target), and the high commodity and oil prices are feeding through to producer prices, and low unemployment could put upward pressure on wages.
Greenspan talked about froth in the housing market many years ago, but right after that, came out and promoted ARMs. He wanted to be liked. That was his biggest problem. His desire to be popular was bigger than his desire to do the right thing. Volcker was unpopular for raising interest rates in the 1970’s to 19% (?), but Greenspan lacked the will to do the right thing. He was our bubble man.
I have learned all this since coming to piggington in November, and I don’t understand a lot of this stuff. But like you, I started with housing and found that the global economic policy is the basis for understanding it.
