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Wednesday, December 17, 2008

Fed: We’re going to zero

Yesterday the Federal Reserve cut the discount rate to 0.50%. They talked about the diminishing threat of inflation and a commitment to promoting price stability and growth. There are unprecedented credit problems within the economy at so many levels. Previous comparable real estate troubles resulted in significant US stock market declines from 1929-1932 (down 90% peak to trough). The Fed pursued a much tighter and more restrictive policy then. The good news is the current Federal Reserve has proactive policy in place to combat the biggest threat to financial stability this country has ever faced. The bad news is it may not matter. The administration (Treasury and Fed) continue to try to loosen credit conditions by replacing frozen credit vehicles with fresh money, as if the problem is that there is not enough lending. There remains too much credit outstanding and it will require some time to repair the damage to consumer balance sheets. Americans are rightly more concerned about maintaining what they have than picking up new credit obligations. It's not the lack of lending – it's the lack of desire to borrow. Businesses borrow to fund anticipated growth opportunities and businesses see no growth opportunities at present – most seem to expect a dour 2009 at least. That will not spur demand for loans, just for refinancing. It's not about growing here – its about surviving.

Perhaps a better comparable to our current woes is Japan, which burst a real estate bubble in 1990. Interest rates in Japan did not hit zero percent until 1996. There was a brief rally during the cuts but those rallies became the highs over the next several years and not the lows in the stock market. Though the Nikkei's slide had already brought it from 38000 to 20000, it continued to spill for the next several years, reaching a low in the low 8000s – a decline of some 77% and 13 years from its 1990 high.

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