All Good Things...

By Daniel O'Connor of Integral Ventures, LLC

In a recent post from Angry Bear, Kash offered his own perspective on the worldwide glut of dollars:

"The failure of long-term interest rates to rise recently as the Fed has pushed up short term rates has been puzzling to many observers recently, and troubling to some.  But I think that the explanation is simply that long-term bonds are one of the only places left for all of this liquidity to go.  As we know, much of this newly-created money has ended up in the hands of a few Asian central banks, and they are not in the habit of putting their liquidity into purchases of goods and services, or stocks, or real estate."

his creates what I think is a surprising paradox: the unusually low long-term interest rates that the US is currently enjoying may in fact be the direct result of the US's financial imbalances, since that is exactly what has put so much of the world's liquidity into the hands of those Asian central banks.  And those financial imbalances are in turn the result of the US's poor savings.  So in a bizarre twist, we may be experiencing a situation where the US's lack of saving is what is actually keeping interest rates low..."

Makes sense, in a mutual causal sort of way.

We seem to have a vast, global positive feedback loop in which the Fed's easy-money policy begets, via foreign central bank efforts to maintain non-market-based exchange rates, asset price inflation in US Treasury securities that manifests in much lower interest rates, which in turn facilitate excessive growth in US government borrowing and spending, asset price reflation in the stocks of corporations now flush with cash, more asset price inflation in mortgage-financed residential housing and, via cash-out refinancing and consumer credit lines, a multi-year marathon of consumer spending that has fueled outsized current account deficits and continuing market pressure for dollar devaluation that would certainly have happened were it not for foreign central banks' willingness to accept irrationally low returns on their US Treasury securites in exchange for the continuing growth of their exports to America's increasingly indebted but nevertheless undaunted consumers who have come to depend upon central banks' profligate monetary policies in order to maintain the modest pace of this credit-rich, saving-poor economic recovery... and, um, well it keeps going round and round...

But, as they say, all good things must come to an end... eventually.

© 2005 by Daniel J. O'Connor.  All Rights Reserved.