Trading Diary

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Dr. Minsky the economist proposed theories linking financial market fragility, in the normal going of an economy, with speculative investment bubbles endogenous to financial markets.

Basically, Minsky found that in prosperous times, when corporate cash flow rises beyond what is needed to pay off debt, a speculative euphoria develops, and soon thereafter debts exceed what borrowers can pay off from their incoming revenues, which in turn produces a financial crisis. As a result of such speculative borrowing bubbles, banks and lenders tighten credit availability, even to companies that can afford loans, and the economy subsequently contracts

Disagreeing with many mainstream economists, he argued that these swings, and the booms and busts that can accompany them, are inevitable in a free market economy, unless government steps in to control them, through regulation, central bank action and other tools; such mechanisms, in fact, came into existence in response to the Great Depression. He opposed the deregulation that characterized the 1980s.

“Looking at the economy from a Wall Street board room, we see a paper world – a world of commitments to pay cash today and in the future. These cash flows are a legacy of past contracts in which money today was exchanged for money in the future. In addition, we see deals being made in which commitments to pay cash in the future are exchanged for cash today. The viability of this paper world rests upon the cash flows…that business organizations, households, and governmental bodies, such as states and municipalities, receive as a result of the income-generating process. The focus will be on business debt, because this debt is an essential characteristic of a capitalist economy.” Hyman Minsky, “Inflation Recession and Economic Policy,” (p. 63) “

The everending cash flow is the most important part of the bubble.Will the fed continue the availability of the cash flow by a rate cut.

 The problem in financial markets is a liquidity issue and not a wider economic issue. The Fed does not have a mandate to change interest rates purely for providing greater liquidity. The Fed has other tools at its disposal to help with a liquidity problem, something it is currently working at with the markets and major banks.

 The US economy grew at an annualized 3.6% growth rate in the second quarter. All the evidence thus far for quarter 3 points to further economic expansion, albeit at a slower rate. It would be unprecedented for the Fed to lower the fed funds rate for the purpose of trying to stimulate growth based on current economic data.

 US inflation has been at or above the Fed’s comfort zone all year and the core consumer price index has been running at a 2.2% rate for the past 3 months, signaling a bottoming out, having come down from a high of 2.9% at the end of 2006. US CPI inflation has not been under the 2% comfort line in over 3 years. With a weak dollar adding to imported inflation, higher energy costs and unemployment at historic lows, there is every reason why inflation should remain at the top of the Fed’s agenda right now and why it would be premature to ease the fed funds rate. In fact inflation in the US is currently higher than that in the euro area and the UK, where the Central Banks remain a firm tightening bias.

The current credit crunch has not run for long enough to have had any meaningful deflationary impact on prices so the risks to inflation remain to the upside as per the statement from the August’s FOMC meeting.

 A reduction in interest rates now would see a rush of liquidity to the market that would have an inflationary impact on consumer prices and could see the Fed having to reverse course and increase rates again early next year. That in essence means it would be a mistake to reduce rates now.
6. Market volatility and uncertainty because of bad debts and risky investments is not the Fed’s problem and is not something that should trigger changes to monetary policy. It is also not the Fed’s responsibility to come in and change monetary policy to help investment companies and speculators that got it wrong.

 The current downturn in equity markets is a long overdue correction. The apparent credit crunch is a reality check and overall it is good for the economy in the longer run. Monetary Policy intervention is neither required nor justified.

With moderate to good growth in the economy and an upside risk to inflation, easing interest rates in this scenario would be akin to pressing a panic button and could have the reverse impact of that desired and plunge the wider economy into major difficulty.

The US carries a major current account deficit and relies on foreign purchases of US securities to offset against this deficit. A reduction in US interest rates at a time when rates are rising elsewhere would lead to an erosion of foreign investment, needed by the US to balance its current account.

 The dollar is already riding near all-time lows and the greenback would probably come under attack if interest rates were reduced. A broadly weakening dollar would lead to higher imported inflation, less appeal for dollar-denominated assets, possible central bank diversification away from US dollars and ultimately reduced purchasing power for US importers and US consumers. This would place the US economy in a much weakened position in the longer run.

I feel that we will have two great international financial events in september.US FED rate cut and Japan BOJ rate increase.The World Financial Thinktanks hope to provide stabilty by this two opposing events.