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China keeping US long term rates down Original Source Link: (May no longer be active)
http://www.fortune.com/fortune/articles/0,15114,%20%09%201079386,00.htmlhttp://www.fortune.com/fortune/articles/0,15114,%20%09%201079386,00.html
FORTUNE - Features
ONLINE EXCLUSIVE
Four Reasons for the Fed's Continuing 'Conundrum'
Another Fed rate hike fails to pull up the long-term rates that really matter. Some global theories on why the private-sector rate-makers aren't playing Greenspan's game.
By Peronet Despeignes
The Fed raised its short-term interest-rate target by a quarter-point for the ninth straight time at its meeting this week, to 3.25%. But who cares? The long-term rates that really matter to many borrowers—home buyers, bondholders and big business alike—aren't budging. The 10-year Treasury bond yield, which guides mortgage and other long-term interest rates, fell another 3 basis points, to just 3.96%, on the heels of the Fed's latest move. That's less than one percentage point away from 40-year lows.
Such a flattened "yield curve" (reflecting the narrowing between the Fed's short-term interest rate and the markets' long-term ones) has typically meant a recession is coming. Yet few economists, least of all those at the Fed, believe that's what's happening. Greenspan calls this disconnect "a conundrum." Others say it's easily explained, and those theories are worth considering.
1) There Really Is a Slowdown. Maybe the global economy really is slowing, in ways that the monthly economic data haven’t caught up to. Slower economic growth makes companies less likely to borrow money in order to expand operations. Reduced demand for borrowed funds means that it costs much less (in the form of lower interest rates) to tap those funds. There's some evidence today that "old" Europe and even China are cooling. The economies of Germany and France, in particular, are struggling to grow amid high energy prices, a euro that has appreciated significantly over the past year and dampened exports.
2) U.S. vs. China: The Battle of the Central Banks. While the Federal Reserve is trying to siphon liquidity out of the U.S. system, China's central bank is effectively pumping it back in by pouring its cash into U.S. Treasuries in an effort to keep its currency, the yuan, undervalued and its exports underpriced. That drives U.S. yields down. In effect, China—and other Asian nations playing the same game—are helping to keep long-term interest rates lower in the U.S. than they would otherwise be.
3) Globalization: A recent analysis by Goldman Sachs argues that globalization may be a major factor behind depressed interest rates. Among other things, it has effectively shifted the balance of power—and income—away from low- and middle-class workers in industrialized countries, and toward high-income workers and corporations, who tend to save a larger share of their income and profits. In effect, savers have been given more to save and spenders less to spend, thanks to this income shift. The end result is a wider pool of savings from which to borrow—lenders have more to lend, and that means lower interest rates.
4) Globalization (II). Others, including Ben Bernanke, former governor at the Federal Reserve and now chair of the White House Council of Economic Advisers, have pointed to what they describe as a more general increase in the global supply of savings. For a number of reasons, many people and governments abroad are simply choosing to save more of their income and put that money into what they perceive, for now at least, as the safest investment in the world: the U.S. and U.S. government bonds. Jitters over terrorism and any of a number of increasingly plausible apocalyptic scenarios—involving North Korea, the Middle East, China-Taiwan, you name it—could be drivers behind this.
Or maybe Greenspan's Fed is a victim of its own success, and more than two decades of low inflation has convinced many Americans—consumers, investors and corporations alike—that the beast is dead, or at least thoroughly tamed. This could change as the end of Greenspan's tenure approaches and uncertainty grows over how the Fed—and the economy—will behave in the post-Greenspan era.
Greenspan may be waging what should be his final interest-rate campaign out of a genuine fear of inflation, or a desire to deflate a housing bubble. Or he may simply be doing a little legacy-building—trying to leave the central bank with some wiggle room after bringing its short-term rates down to 1% after the dot-com bust and 9/11. For now, though, one thing seems clear: The larger market isn't following the Fed's cues when it comes to tightening the money supply.
Greenspan and the Board of Governors still garner plenty of attention for their every utterance, and around meeting time Wall Street still pauses to cock its collective ear towards Washington. But just as OPEC has found itself powerless to move oil prices in the face of traders' fears of refinery bottlenecks and supply ruptures, the Fed these days is up against a global marketplace marching to its own tune.
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