Steve Roach is the Chief Economist at MorganStanley.  To put it mildly he doesn’t much like the economic situation in the United States.

“In all my years in this business, never before have I seen a central bank attempt to spin the debate as America’s Federal Reserve has over the past six or seven years.   From the New Paradigm mantra of the late 1990s to today’s new theories of the current-account adjustment, the US central bank has led the charge in attempting to rewrite conventional macroeconomics and in making an effort to convince market participants of the wisdom of its revisionist theories.  The problem is that this recasting of macro is very self-serving.  It is a concentrated effort on the part of the Fed to exonerate itself from the Original Sin of failing to address asset bubbles.  The result is an ever-deepening moral hazard dilemma that poses grave threats to financial markets.”

“Unfortunately, the asset-based spending model has given rise to many of the distortions and imbalances evident in the US today.  That’s especially true of low saving rates, the housing bubble, high debt loads, and a runaway current account deficit.”


“The rhetorical flourishes of America’s central bankers have dug the US economy — and by definition, a US-centric global economy — into a deep hole.  To this very day, the Fed has never confessed to the Original Sin of condoning the equity bubble.  On the contrary, Greenspan & Company have been on the defensive ever since by dismissing the increasingly dangerous repercussions of the original post-bubble shakeout.  Far from playing the role of the tough guy that is required of independent central bankers, the Fed has become an advocate of the easy money of a powerful liquidity cycle.  One bubble has since begotten another — from equities to bonds to fixed income spread products (i.e., emerging market and high-yield debt) to property.  And financial markets have gone along for the ride — not just in the US but also around the world as global investors and foreign central banks have rushed with reckless abandon to finance America’s record current-account deficit. “

“The day is close at hand when US monetary policy must get real.”

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During much of the last 4 years the net interest rate was zero.  That means the major money market banks and the Federal Goverment were being charged nothing to borrow money.  This money fueled the asset boom, primarily housing, which in turn fuel current consumption as Americans borrowed their home equity to spend on ‘consumer non-durables.’  (This is a fancy way to say Americans have eaten and are wearing their homes.)

As Americans have moved away from fixed mortgages to ARMs they have exposed themselves to the inevitable rise in interest rates that must occur for the housing bubble to burst.  Currently, in the most populated areas of the US, housing prices are beyond the financial ability of the average US worker to buy.  The prices are rising purely from the expectation prices will continue to rise.  

Concurrent with a projected rise in monthly house payments are rising transportation costs from the rise of oil prices.  So not only does it cost more to continue to live in the homes it also costs more to pay for transportation to get to the job required to earn the money to pay for the home and transportation.

This combination means there will be less discretionary monies available for consumer goods including those goods produced by the Asian emerging economies who purchase the financial instruments – bonds – to fund the current account deficit (Federal plus consumer debt.)  Thus breaking the unwritten compact: they buy our bonds and we buy their stuff.

By breaking the compact these Asian nations will no longer have the economic incentive to purchase Treasuries, this loss of market indicates yet higher interest rates on those instruments to attract marginal buyers.  This would fuel yet higher interest rates on ARMs, raising monthly payments, limiting consumer spending yet more in a classic ‘negative feedback cycle.’

One more item, as Mr. Roach wrote we live in, “…a US-centric global economy…”  When the US consumer is finally faced with economic reality it isn’t only the US that is going to be affected.  The whole worlds economy will be affected as well.  How badly is anyones guess but it isn’t going to be pretty.

The way out of this situation is (not so) simple:  (1) the Federal Goverment must reduce spending and raise income (taxes) to lower one side of the current account deficit, (2) the American consumer must pay down their debts, stop spending like a Drunken Republican on Steroids, and save to pay off the other side of the current account deficit, and (3) American corporations must stop playing fiddle-fuck games with their corporate accounts and start producing goods and services people actually want to buy in order to earn the money to pay back the interest and principle on the monies already borrowed.

The Federal Reserve has allowed US monetary policy to wander off into La-La Land.  Refusing to face reality the Fed has continued to pump up the money supply – the fuel of the whole shebang.  Until, and unless, the Fed reins in we are only going to see the problem deepen and a deeper world-wide economic contraction.

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