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China keeps long term mortgage rates down { May 30 2005 } Original Source Link: (May no longer be active)
http://www.msnbc.msn.com/id/8089630/http://www.msnbc.msn.com/id/8089630/
Why aren't mortgage rates going up?
MSNBC.com answers your questions on business, personal finance
By John W. Schoen
Senior Producer
MSNBC
May 30, 2005 - With the folks at the Fed pulling the levers to make interest rates go up, Gus in North Carolina is puzzled why mortgage rates don’t seem to be moving higher. (He shouldn’t feel bad: even Fed head Alan Greenspan calls it “a conundrum.”) Meanwhile Eric in Illinois wants to know if the next generation of auto technology -– from hybrids to hydrogen fuel cells -– will throw a wrench into his plans to become a car mechanic.
RATE CONUNDRUM
Why do mortgage interest rates continue to remain so low, even while the Federal Reserve is raising bank interest rates? — Gus D., Wilmington, N.C.
The Federal Reserve sets short-term rates: literally, the “overnight" cost of money. This so-called “fed funds” rate is the rate one bank pays another for borrowing money overnight. The reason banks borrow from each other is to maintain what are called minimum reserve requirements. If you’re a bank and you have, say, $500 million in loans outstanding, you’re required to keep a minimum percentage of those loans, in cash, at all times. So if one day Bank A lends out a little more than it can cover with reserves, it borrows from Bank B, which happens to have a little extra.
Long-term interest rates (which include mortgage rates) are an entirely different animal. These rates are “set” by the bond market, just the way the stock market “sets” stock prices. Banks, brokerage firms, pension funds, foreign countries, mutual funds, insurance companies and individual investors bid for bonds when the Treasury sells them every three months. The more demand there is (the higher the “bid”), the less the Treasury has to pay in interest rates to sell them. (The Fed can, and does, try to tinker with long-term rates by buying and selling bonds that it holds. But as big as it is, the Fed can’t control the global bond market.) These bonds are then bought and sold all day long, fine-tuning long-term rates between Treasury auctions. And because the Treasury market is so large and liquid, other long-term loan rates -- like mortgages -- tend to follow suit.
So now the basic question: why is demand so strong for those U.S. Treasury bonds? Mr. Greenspan himself recently called this “a conundrum.” But some economists have speculated that the answer lies with countries on the other side of our trade deficit, especially China. The theory goes something like this:
Say you buy a new pair of sneakers at Wal-Mart -– or kitchenware, or electronics, or tires -– that were made outside the U.S. A few of your dollars end up at Wal-Mart headquarters where they're booked as profit in the company’s next quarterly earnings report. A few more dollars wind up in the hands of the American company that imported your new sneakers. A few more go to the truckers and owners of cargo ships that brought them to you. But a significant chunk of your dollars end up in the country where the products were made.
Last year, something like $650 billion ended up outside the U.S. The country with the most, China, took in $162 billion in 2004. Oil producers, lead by Saudi Arabia, received $164 billion from American purchases of gasoline, heating oil and other products made from crude oil.
So what would you do if you were one of those countries with a piece of that $650 billion? You can’t spend it on goods and services: your country has already bought all the stuff from the U.S. that it needs, wants or can afford. You could put it in a bank, but for many countries holding surplus trade dollars, especially those with shaky banking systems, that’s not necessarily the safest place to put it.
Eventually, those U.S. dollars come back home -– in return for I.O.U.'s from Uncle Sam called U.S. Treasury securities, still one of the safest places in the world to stash cash. As long as our Congress continues to spend more than it raises in taxes, we’ll have plenty of that Treasury debt to sell. All that demand helps keep interest rates low.
One reason China is getting so much attention -– aside from the huge chunk of the trade deficit it generates -– is that it has kept its own currency, the yuan, artificially low by pegging it to the dollar. No one knows just how much it would rise if it was allowed to “float” –- but the strength of the Chinese economy indicates that the yuan should be valued considerably higher relative to the dollar.
President Bush has been pushing the Chinese to let the yuan float. If the yuan rises against the dollar, Chinese products don’t look so cheap anymore. But China has been resisting the move, in part, because it already holds close to $225 billion in U.S. Treasuries. If the dollar weakens relative to the yuan, that investment in Treasuries shrinks in local value. By keeping yuan fixed, Chinese officials are preserving the value of their investment.
If the dollar slides gradually, all of this may work out just fine. But a sharp drop in the dollar would almost certainly bring higher long-term interest rates in the U.S. (including mortgage rates.) Nobody wants to buy U.S. Treasuries (denominated in dollars) today if they know they’re going to be worth less tomorrow. So if foreigners stop buying the paper being used to fund our federal spending spree, long-term interest rates could rise sharply.
Something to think about next time you’re looking for a new pair of sneakers at Wal-Mart.
NEXT-GENERATION MECHANICS
I plan on being a mechanic in a few years and I was wondering: with Bush talking about converting cars to hydrogen and selling more hybrids, how would this affect my future occupation? Will it still exist even with all those hydrogen cars on the road? — Eric S., Moline, Ill.
Don’t trade in your ratchet set just yet, Eric. Despite the hype and hoopla about hydrogen, it will be decades -– at least -– before hydrogen replaces gasoline as the motor fuel of choice. (Some energy analysts believe it may not happen in your lifetime.)
For starters, to switch to hydrogen cars, we’ll have to figure out how to develop a system of making and distributing enough hydrogen to keep the more than 130 million cars on the road topped off. Even if that system were in place today, it would take years for automakers to replace all the gasoline-powered cars out there.
You will soon see a lot more gas-electric hybrids on the road, especially if gasoline prices stay above $2 a gallon. But of the roughly 17 million cars expected to be sold this year, you can still count the number of new hybrids sold in the tens of thousands. Even if gasoline prices shot up to $5 a gallon, it would take automakers years to ramp up hybrid production to 17 million cars a year.
And no matter what technological changes are made to the automobile, you can rest assured that any piece of machinery they come up with will break down at some point. Most of the technologies that will eventually replace the 100-year-old internal combustion engine are still being developed. And the faster automakers try to ramp up production of cutting-edge technology, the more likely they are to turn out cars that need repair. So we foresee a bright future for auto mechanics.
Still, tomorrow’s mechanics will need a completely different set of skills than the generation that could diagnose a bad carburetor just by listening. As carburetors have gone the way of tail fins, cars have become computers on wheels. Increased fuel efficiency, advanced combustion processes, the introduction of electric-driven drive trains — all of these changes will require a higher level of technical skill from the folks we’ll all turn to when these vehicles eventually conk out.
Our guess is you’ll still have to be handy with a torque wrench. And you won’t need a degree in chemical engineering to fix a fuel cell. But you’d better learn all you can about computer diagnostics and electric drive trains. Tomorrow’s mechanics will almost certainly need more training — and more frequent retooling — to service the next generation of cars.
© 2006 MSNBC Interactive
© 2006 MSNBC.com
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