Monday, July 25, 2005

Angry Bear resolves the interest rate conundrum

Angry Bear: "Apparently the renminbi news had no substantial effect on US interest rates.

But that’s not the whole story.

Why do I say that? Because while rates didn’t rise much in the US as a result of the renminbi revaluation, interest rates in most other countries fell, in most cases quite substantially. "

One of the persistent mysteries of the Bush Presidency has been why the financial markets do not appear to be reflecting just what a train wreck his borrow and squander economic policies have been. Policies this perverse and destructive have to have terrible consequences. The thesis (hope?) of a perfect storm is that the consequences are dramatic enough to teach a lesson to the American people. The fear is that, instead, the consequence will not be dramatic -- that the consequence will simply be long, slow decline ("boiling the lobster").

One long awaited event in the unfolding drama, which is the disastrous Bush economic policy was the Chinese revaluation. The U.S. is borrowing enormous amounts from Japan and substantial amounts from China. Borrowing from China, a developing country, is particularly weird, but it serves to highlight the growing power of China relative to the U.S. One important set of events in a perfect storm would be an exercise of power by China to humiliate the U.S., to highlight the change, which the Bush policies have accelerated and exacerbated. The Chinese currency will be rising in value relative to the dollar for many, many years, reflecting a rising economic power in China. But, in the short term, increased Chinese reluctance to continue to loan money to the U.S. government will draw back the curtain, which has obscured the profligacy of U.S. deficits, and impose the pain of high long-term interest rates.

For many months, though, U.S. long-term interest rates have remained stable, even declined relative to short-term rates. It has been a mystery, though many recognized that China's continued purchases of U.S. debt played a part.

Now, the Chinese have revalued, and many expected U.S. rates to rise. (A Chinese revaluation reflects increased reluctance to buy U.S. debt; it is purchases of U.S. debt, which keep the value of the Chinese currency down relative to the dollar.) Only U.S. rates have not risen much, yet.

It is reassuring to see that the world does work the way one imagines -- that is, borrowing and squandering does have predictable consequences. Sadly, events continue to unfold more in a "boil the lobster" way, than the gathering of a storm.

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