Tuesday, December 21, 2004

As everyone knows, Pope Alan and his College of Cardinals (aka the Federal Reserve) have been raising interest rates in the United States all year. From the ultra-low 1.0% in mid-2004, rates at the end of the year stand at 2.25% � 125 basis points of change. 2005 promises much more of the same.

The usual rhetoric from the business press says that the Fed raises the federal funds rate, blah-blah-blah, interest rates across the economy go up. Back in the days of national economies and limited transnational capital mobility, this made sense. If you wanted money, you got it from domestic sources, and your country�s central bank controlled the price at which those domestic sources got their hands on it.

But those days are gone.

Throughout the Bush years the US economy has relied heavily upon the kindness of strangers � especially East Asians but also Europeans, Canadians and even Latin Americans � to fund our ever-burgeoning deficits. Which ones, you ask? Federal budget deficits. Trade deficits. You name it, they�re funding it. With a US savings rate under 1.0%, what do you expect?

But interestingly, those foreign �benefactors� are getting a bit more choosy about where to put their money. And the consequences will be enormous for both the US budget and for Bush�s privatization scheme for Social Security.

In 2003 foreigners net purchased $747.1bn in US long-term securities. They liked US Treasury bills the best (37%) with corporate bonds a close number two (36%). US Agency bonds � i.e. our home mortgages funneled through Freddie Mac, Fannie Mae and Ginnie Mae � were third (22%) and US stocks were a very distant fourth (5%).

I give these numbers so you can compare them to the data from the most recent four months available: July-October 2004. Over these four months, foreigners have net purchased $253.7bn in US long-term securities. Annualized that comes to $761.1bn � just about the same as calendar year 2003. However, the kinds of securities foreigners are interested in now has changed dramatically. Now corporate bonds are a clear number one (46%) far outpacing US Agency bonds (26%). Stocks continue to pull up the rear (4%), but what is most remarkable is that US Treasuries are now down to third place (24%).

What foreign capitalists and foreign central banks are saying is that they are still willing to plow money into the US economy � for now at least. However, they�re interested in more high-yield assets like corporate bonds and home mortgages. US T-bills are just not attractive anymore. Foreign capital to Uncle Sam: No soup for you!

The result is substantially higher growth in interest rates for US debt compared to housing debt and corporate debt.

The above chart shows interest rates since 2001 on Aaa corporate bonds, one-year adjustable rate mortgages, and one-year treasury bills, as well as the federal funds rate. As you can see, since early 2004 interest rates overall have gone up. The Fed�s influence is being felt, we are told. However, look closely and you�ll see that some borrowers are not feeling the pinch quite as much as others.

From their early 2004 lows, the federal funds rate is up 125 basis points (i.e. 1.25%). Interest rates on one-year adjustable rate mortgages have gone up only 49 basis points, however, and rates on corporate bonds have gone up a mere 32 basis points. Clearly a lot of money is available at attractive prices if you�re a corporate or home-buying/owning borrower. Things aren�t so rosy for Uncle Sam, however. Compared to the same late-March lows, rates on one-year T-bills are up a big 145 basis points.

Money is getting more expensive in the US, but only for some borrowers. Uncle Sam wants to borrow and borrow and borrow. And if Bush�s Iraq-like Social Security reform plan goes through, he�ll be borrowing an additional $100-200bn a year on top of the overall budget deficit annually for the next decade. The evidence from 2004 shows that foreign capital and central banks � i.e. the people with the money � will loan to the US government but only if we�re willing to pay a lot more for it.

The numbers also suggest that one very important reason behind the continuation of ultra-low mortgage rates is thanks to foreign capitalists and central banks getting mighty interested in our home mortgages. As long as Japan and China and the rest keep throwing money at the US housing bubble, it will bubble on. But woe to us if and when they stop.

In the age of globalization, don�t think the Fed controls the levers to the US economy. All those savers in Asia and Europe, and central banks in every part of the world, are working things as well. And when they decide � as they are now � to start squeezing more profit out of the US federal government�s insatiable appetite for debt you know who�s really pulling the levers.

(This was my post at The American Street yesterday)


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