Aug 30 2007
The Never Ending Saga of Credit Crunch
As much as I believe the credit crunch is over, I found myself still fascinated by the discussions about credit, interest rate, economy and the Fed. I know it is a little silly but I just can’t help it …
Anyway, yet another great article from Grep Ip, “Bernanke Breaks Greenspan Mold”
Key points:
1. Are the two major duties of the Fed–maintaining financial stability and controlling inflation–so intertwined that a disturbance in credit market will necessarily cause chaos in economy?
2. Historically, Fed has been careful not to lower federal fund rates to deal with credit crsis. Instead, the more “technical” tool of easying discount rate was much more preferred.
3. This was the case until Greenspan came along. He drastically lowered fund rates on two occasions: 1987 and 1998.
4. Greenspan’s rationale: when the animal spirit founders, so will the economy. Therefore, it is necessary to use economy emergency kit to stop credit bleeding.
5. The moral hazard criticism, aka the Greenspan Put.
Thoughts:
I have long had the doubt whether a credit crunch would spill over into the larger economy? This can happen if investor capital is the one most critical element in economic growth. But is this true?
I suspect that today’s economy is so diversified and there are so many sources of growth that neither the investor capital nor capital itself dominates the growth trajectory.
First, many companies may finance their cap ex by their own cash reserves. We all heard about how cap ex lagged behind consumer spending since 2001 yet corporate profits has been good for just as long.
Secondly, the injection of cheap labor may change the production equation: instead of relying on capital-intensive technologies, more and more companies find labor substitute a viable solution.
Therefore, even if capital and economy was as intertwined as Greenspan envisioned back then, they may not be so today.
If Ip was somewhat ambiguous of what he thinks, James Surowiecki made his point pretty clear in a recent New Yorker column. Although he made basically the same argument as Ip did, Surowiecki is a bit unfair toward Bernanke by applying the “moral hazard” label on him. If one looks at the Fed’s track record as compiled by Ip, Bernanke is a “strict constructionist”, borrowing a judicial term, in that he is very careful in distinguishing financial market and the larger economy.