The New York Times online issue of December 12, 2007 carried an article that the US FRB had reduced the interest rate by a quarter percent on December 11, 2007. This was done ostensibly to prevent the crisis in the credit sector and to prevent the economy slipping into a recession. I must say I am very disappointed. In our articles titled Economic Conundrums as being witnessed in USA today and Credit Crunch in USA, we have clearly mentioned that a recession is unavoidable. We had also mentioned that FRB must not touch interest rates any further and any artificial way to pump in money into the economy will lead to more problems.
Unfortunately, FRB has chosen both the options. They have reduced the interest rates as well as promised to pump in money artificially into the economy. What FRB has done is attacking the symptoms. It has not gone into the root cause of the problems the US economy is facing. This will lead to what is known as 'Stagflation'. Now let us look at what this means. When stagnation and inflation occur simultaneously, it is called 'Stagflation'. This is assuming that the economy has not already gone into a recession, though we strongly believe that it has.
Reduction in interest rate will make the money easier for the borrower. People will be able to borrow money at lower interest rates. However, it does not make the borrower any more creditworthy. The borrower must still offer collateral to banks and lending institutions. Where is the collateral going to come from ? The problem is not fully with the borrowers. It is also with banks and lenders. They just do not have enough money to lend after having suffered heavy losses in the housing mortgage meltdown. The savings of people is just not there. There has already been a run on some Florida based pension funds and financial institutions based on rumors that they had invested in some mortgage funds. According to estimates, an average American is indebted by about USD 7000 dollars. This means the deficit is approximately 2.1 trillion dollars.
On one hand the banks and lending institutions do not have liquidity. On the other hand, average Americans are already in debt. By pumping in more money artificially into the system, the economy will witness inflation in some sectors. But the money will not be underwritten by the consumers. The result of these decisions is that there will be stagnation in some sectors of the economy and inflation in some. Both will result in more serious problems for the US Economy. Keynesian theories have caused more havoc to global economies than all other natural and man made disasters.
It is rather a sorry state of affairs with one voice of dissent on cutting of interest rates by the FRB, Boston Chief. However, he wanted the interest rate cut by 0.5% as against 0.25% ! FRB must freeze the interest rates at least now, before it is too late. The new year 2008 does not look very bright and promising for the US & global economy and that will be an under statement.
Copyright. December 13, 2007. www.madgopes.com. Without Prejudice. All rights reserved.
Stagflation, Credit Crunch and FRB Policies - To learn more about this author, visit Madhavan T Gopalachary's Website.
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Madhavan T Gopalachary
(Visit Madhavan's Website)
Madhavan Gopalachary, nick name "madgopes"
(g pronounced as in go) given by IIT
classmates, is a Mechanical Engineer and
an alumnus of Indian Institute of
Technology, Madras having passed out
specializing in IC Engines &
Thermodynamics.
He has nearly 35 years of experience in
the Corporate World. He started off as a
trainee and handled sales, marketing,
manufacturing, product management, profit
center management, strategic planning and
corporate development including R & D in
various organizations and at various
levels before becoming a CEO. His last two
professional assignments were at CEO level
before embarking to start management
consultancy business on January 01, 1998.
He has worked for British, Swedish MNCs as
well as very large Indian business houses.
He has spent a large portion of his time
from June 1998 till date in East African
Countries practicing as an independent
Management Consultant.
More details can be obtained at the
following web sites:
mmg.name
/mtg.html;
mmgconsu
lting.biz/
Madhavan's articles can be accessed at www.madgopes.com
.
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