Saturday, May 14, 2005

Economic Slowdown

I was having a discussion with some of my CPA colleagues over a few pops yesterday and we were talking about the overall state of the U.S. economy. We all expressed our concrens over what was going on, and were not sure about which way the economy is going. I think that we are going to have a bit of a slowdown. Here are some of the key points I think deserve mention.

  • The weak U.S. dollar is due to three things: Defecit spending is increasing the supplly of U.S dollars, and increased consumer spending financed by low interest rates and inflated housing values. According to Rich Bernstein, Cheif Quantative Strategist at Merrill Lynch, most of spending in the last few years has been sustained by people using home equity lines with variable interest rates. They are spending in excess of their discretionary income as a result. These three items are driving the U.S. dollar down in the intermediate term.
  • What can be done about it? The obvious answer is to somehow soak up this excess liquidity that is being used for consumption. In this sense, the increase in oil prices have helped to slow down spending. There are three main ways to slow down the consumption: raise taxes, run surplusses, or raise interest rates. In light of the current political circumstances neither raising taxes or running surplusses will happen. Greenspan has telegraphed his intentions about interest rates. He has warned that those who are in variable rate loans are asking for trouble. Increasing interest rates will force consumers to de-leverage their home equity loans, and will cool off the housing market. But the Fed has to be careful because if rates go too high, it will hurt investment and business activity. Greenspan has a delicate situation in front of him.

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