A punch bowl made in China
A FORMER FEDERAL RESERVE CHAIRMAN once famously said it was the central bank’s job to “take away the punch bowl when the party is warming up.” That’s precisely what Alan Greenspan and his colleagues at the Fed have been doing for more than a year now, as they have gone about methodically raising the overnight federal funds rate from 1% to 3.5% -- with Tuesday’s quarter-point move marking the 10th increase since June 2004.
But these moves haven’t been putting that much of a damper on the party. Long-term interest rates have not risen in tandem with short-term rates; oddly enough, long-term rates are lower than they were before June 2004. The convergence of short-term and long-term rates usually signals a recession (when there is little demand for investment capital driving up long-term rates), but in this case there is a different explanation for the Fed’s failure to nudge long-term rates higher. Quite simply, China is supplying a punch bowl to keep the party going.
So all those revelers buying houses and going on shopping sprees can thank Beijing and other Asian central banks for all that cheap credit. By investing so heavily in U.S. bonds, these countries are subverting the Fed’s tighter monetary policy.
At one level, this is the best of all worlds. The U.S. economy is growing at a healthy clip and adding far more jobs than any other developed economy -- more than 200,000 alone in July. Consumers and businesses are confident. Corporate profits are rising, and the specter of inflation -- which is driving the Fed’s party-dampening moves -- remains tame despite a surge in oil prices. One reason is that wages have been inching up at a modest pace, though a tightening labor market and a slowdown of productivity growth could accelerate wage growth.
On the surface, then, Greenspan is presiding over a rosy scenario as he enters his last semester at the helm of the Fed (he is scheduled to retire in January). But a market economy, even under the best of circumstances, is a fragile balancing act, and the chairman can only wonder whether he hasn’t traded in the dot-com bubble for a real estate bubble.
That same Chinese punch bowl that is helping to stave off inflation is also encouraging Americans to go further into debt as they make ever bolder bets on the continuing appreciation of real estate values. With China foiling his efforts to end the party gracefully, Greenspan is left to wonder whether that perilous real estate bubble will be part of his legacy.
