Tuesday, October 25, 2005

Goldilocks

Strange music in the background is cause by the second article older than this one. The Iraqi constitution just passed (78 percent).

One of our former undergraduate students here at Harvard, Ben Bernanke, was chosen to replace the economist. The Reference Frame thinks it's a good choice. Bernanke introduced the concept of "goldilocks" to economics: not too cold, not too hot. This applies to inflation and deflation in particular.



We hope that he realizes that things could become too hot very soon and he will raise the interest rates to something like 6-7 percent sometimes in 2006. You know, the Americans are not afraid to borrow money. They're self-confident and optimistic enough which is one of the reasons why the U.S. interest rates should be, in average, significantly higher than the interest rates in other countries where the people are shy (such as Japan, obviously, but maybe also Europe).




Too low U.S. interest rates contribute to the huge U.S. trade gap; they may actually be the primary reason behind it. The more the Americans borrow as a group, the more they must import - ignoring "second order" effects such as the growth. :-) But maybe I should no longer give Bernanke lectures; as mentioned previously, he is a former student of Harvard. ;-)

5 comments:

  1. Lubos:

    Whoever replaces Greenspan will be put into a position very tough to handle, almost mission impossible in my opinion.

    I wish you have a more realistic and balanced view on economic matters. It would take some one who have lost sanity completely to raise the Fed rate to 6-7 percent in 2006. Because that will totally destroy this country as we know it.

    Current US national debt is 8 trillion dollars, at 6.5% Fed interest rate, you are paying over half a trillion just to pay the interest.

    Also you have not bought a half million house which now grows to almost a million, so it's lightly for you to say 6.5% fed rate. For any one who has a mortgage, especially those with interest only loans, which a lot of Americans do, 6.5% fed rate and hence 9% mortgage rate would spell a complete disaster, destroying the economy completely.

    I think the economy is currently in such a fragile state than even continue to raise interest rate from current level would be very dangerous. But whatever the fed does, it doesn't look good in the next few years, especialy as the oil peaks.

    Quantoken

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  2. Dear Quantoken,

    I understand very well that the people who have borrowed much more than what they can normally afford start to suffer a bit as the interest rates grow. But borrowing more money than what is possible is exactly the source of many of these problems - growing debt, trade gap, even budget deficit, and so forth.

    It's one of the points to make these people who create all the gaps suffer a bit.

    These spiralling problems must be stopped from an exponential growth whose endpoints may be unpleasant not only for the US economy. And a solutiuon is not to support the exponential growth and reduce the interests for the loans, which simply encourages even more loans.

    I am sure that the next Greenspan will also be under a pressure from many people who want permanently low rates, but I hope that he or she will resist. This is a road to hell.

    I don't believe that higher rates are so counter-productive for the whole U.S. economy. Some of the economically best times have been in the high rate environment. High rates have a lot of advantages, too. They will naturally support savings, exports, reduction of gaps of all types.

    I said 6-7 percent because I wanted to stay moderate. I can imagine that if things work out in the "warm" way, the rates should eventually peak close to 8-9 percent.

    There is no good reason why New Zealand should have permanently higher rates than the U.S.

    To summarize: I do believe that the interest rates are the primary regulators affecting the gaps, and there is no "universally unhealthy" development in the economy that can't be improved. It would actually be healthy for the U.S. to try to return to an era of surpluses - both budget surpluses (not seen since 1999) as well as trade surpluses (not seen since the early 1980s). It should not be done for any price, but the inability of the U.S. to balance these things in the medium term would signal that something is breaking down, indeed.

    This is where it should go. Rates closer to 10 percent than 3 percent; surpluses; dollar around 140 yen and 1 euro, which will help to lower the trade gap even more in the short term because the US will get things cheaper. There should be more balance and higher interest rates are a necessary assumption.

    Note that the crackpots in most countries of the world can't afford to buy $1 million houses, and those in the U.S. should think twice whether they are so much terribly different.

    Best wishes
    Lubos

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  3. Lubos:

    Crackpotists in the USA can't afford $1M houses either, like those work in the super string theories. But any one who has some crackpot ideas in the industry could. You must think that tearing lettuces up is a childish thing to do? That's a $10M invention in actual reality!

    I did not buy my house using interest only loan, but I really worry about the folks that do. The real estate market is going to collapse and it will bring down the rest of the economy, together with jobs and all that. Super string theorists who live on the moon may be immune but no one else escapes. What makes you think 6-7% fed rate is a moderate rate. It's an extremely high rate that absolutely destroys everything, especially at this stage of the economic game.

    Dollars at 1 enro will be a dream. But no currency is safe. I am thinking of buying gold and buying land in places where sustainability is possible post oil peak.

    They released a huge amount of strategic petroleum reserve to balance the oil price, and people in the main stream media start to think that the supply and demand has reached equilibrium and all is fine. What an illusion! It's like one thinks he can have a good night's sleep in the bedroom because only the living room is on fire. Time to start building a Noah's Arc for oneself, before things make a worse turn.

    Quantoken

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  4. One amusing fact - Interest rates of 10% would cut growth considerably more than full implementation of the most extreme form of the Kyoto climate treaty.

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  5. They would reduce the growth by about as much as they would reduce the debt of various forms.

    Kyoto protocols would, on the other hand, reduce growth and increase the debt of all forms.

    Drastic versions of Kyoto are nonsensical fairy-tales as you know very well, CIP. In this sense, I do agree that changing of interest rates is more influential for the economy and it must be more influential than one particular weird idea of one particular group of environmental activists who call themselves climate scientists.

    It would be a real disaster if some of these "protocols" started to have the same or bigger effect as the most important regulating tool for macroeconomy.

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