Aug 22 2007
The Fed hints at interest rate relief
The Head of the Fed is at the moment the most important and powerful person for the world economy.
He came to office after the much liked Alan Greenspan. Greenspan had kept world markets and the world economy marching ahead, by slashing interest rates every time there was a financial squall, to prevent the losses getting out of hand and to prevent the real economy suffering too much. He was able to do this thanks to the arrival of super competitive China and India as large scale suppliers, keeping prices down however much the west borrowed.
His successor was well aware that this method of managing had created huge mountains of debt that could become unstable if interest rates went up too much. He also knew that all the time markets expected interest rate cuts everytime financial institutions got into difficulties, there would be little discipline in lending and no proper appreciation of risk by bankers and funds.
He decided that interest rates needed to be raised to give these financial insttiutions a warning that they needed to become more prudent in their lending. He was also aware that the China effect on prices might not last for ever. Chinese demand became so large it started to drive up oil and commodity prices, shipping rates and some Chinese salaries and wages, whilst at home domestic wages and prices could rise on the back of ever ready credit.
His early interest rate rises caused no great problems. No doubt Mr Bernanke was well aware that there would be lags, but because he also knew the debt problem was so large he kept hiking rates. By this summer the combined impact of much higher rates and the delayed response to earlier rate rises induced the sharp sell offs we have been witnessing in the last two months.
Now we learn that Mr. B has hinted that he will do whatever it takes to “stabilise” markets. That would mean we are back to the Greenspan approach, cutting rates to stop too many people defaulting and to keep the debt machine well oiled. Watch this space: that would change things quite a lot.
RSS Feed
John Redwood has been the Member of Parliament for Wokingham since 1987. First attending Kent College, Canterbury, he graduated from Magdalen College...
It pleases me greatly to see that John Redwood is following events so closely. What happens globally will impact on us at some point. The rise of China and India has certainly altered the financial dynamic. It will be particularly interesting to see how the Chinese cope with an ever expanding economy. The more they intergrate through trade the more they will be subject to meeting western standards of production and I wonder how that may effect price levels. The Chinese are currently predicting that they are to overtake the United States to become the world’s second largest exporter if current export-growth speed is maintained. In the opening half of 2007 China’s total exports grew a staggering 27.6% to reach a total of 546.7 billion dollars.
Reply: As China grows her goods will become more expensive. Cheap production will migrate elsewhere in Asia and even in Africa - just watch how China is buying up African resources and trying to settle people in Africa. Cf the rise of Korea as Japan moved to dearer goods in the 1960s and 1970s.
You are right about the way China is planning to use Africa as an economic base and source of dirt-cheap labour. The old style communist trick of offering ‘Aid’ and ‘Mutual co-operation’ to get a foot in the door still applies. The west must not allow Africa to fall under China’s sphere of influence. China will not bring democracy or free-trade to Africa. China’s primary objective is imperialistic.