Aug 20 2007
More WSJ Articles on Recent Credit Crisis
I dare say that the current credit crisis is about to blow over (partly because I can’t take it any more:) Nevertheless, can’t help but to take down notes on two interesting articles I read this morning.
“Foreign Investors View Dollar As ‘Refuge Currency’ Despite Recent Tumult”
One of the best international trade and investment primers I’ve read. Mark Whitehouse makes it clear that trade balance is the result of simultaneous push (e.g. foreigner’s willingness to lend) and pull (e.g. American’s desire of foreign goods). It is not as if the trade deficit creates a void that is filled later by the investment inflow. Instead, each force has its own supply and demand relations. Labor activists and Lou Dobbs may paint a picture of foreigners baiting Americans with cheap goods then buying our securities as a financial hostage. But that is B.S.
The question of the article: normally, when the Fed is about to cut rate, the dollar should depreciate. But dollar acutally strengthened against euro even as U.S. financial market is under such duress. Why?
The answer is that currency exchange function has both interest rate and risk premium as variables. When risk is high, risk premium is a more prominent factor than the interest rate (just think of it as a multi-variant sensitivity analysis). In other words, under such a circumstance, the risk factor determines the exchange rate.
After the Cold War, the U.S. is said to have reaped the “peace dividend”. Is it safe to say that after the 97 Asian financial crisis, U.S. has been reaping the “stability dividend”?
“How a Panicky Day Led the Fed to Act”
The play-by-play recount:
- Thursday, “as the day dawned in London,” normally very fluid commerical papers went stale. Finally, “on Friday morning, following a conference call the previous evening convened by Chairman Ben Bernanke, the Fed blinked.”
- ECB declared that it was ready to offer “unlimited funds” to defend the 4% target rate.
The political factor:
- “When you start talking about Countrywide,” said one senior Wall Street executive, “that’s kind of America. At the end of the day, we’re talking about Mom and Pop and the right to own a home.”
The history factor:
- Fed Chairman Bernanke, … had long studied episodes like this. In a January speech, he noted that the Fed was founded “in response to the periodic episodes of banking panics and other forms of financial instability that had plagued the U.S. economy during the 19th and early 20th centuries.”
The jumbo mortgage factor:
Fannie Mae and Freddie can’t do it and Countrywide is the biggest player.
My thoughts:
It is not about liquidity. It is all about confidence!
- Commercial banks were flush with cash, yet money-market rates were rising. Something was eroding the banks’ willingness to lend.
- Particularly at times of stress, what the Fed says can be almost as powerful a weapon as what the Fed does.
Recent criticism of Bernanke making “rookie” mistake is unfounded.
- Mr. Bernanke pondered options with his confidants. They included the Fed’s vice chairman, Donald Kohn, an economist who was one of former Chairman Alan Greenspan’s closest aides; and Timothy Geithner, president of the New York Federal Reserve Bank and a protégé of former Treasury secretaries Robert Rubin and Lawrence Summers.