Okay, here’s basically what Paul Volcker is saying:
- The government needs to start unwinding the “bailout” programs that it has done and it needs to do that before it looks like they need to, not after we can all see that we need to.
- If we wait until we can see that we need to do it, it’s too late and the problems are going to get out of control “on the other side.”
- He’s got a lot of credibility in this area because he is the guy who gets credit for stopping inflation back in the early ’80’s but he had to raise rates to 20% to do so.
So what does that mean to interest rates? Particularly the rates that we’re most concerned with, mortgage rates?
A couple of thoughts:
- If the government unwinds their programs (the free money, the ultra low interest rates, etc.) in a systematic and measured response and starts doing so before inflation becomes an issue, I expect that we’ll see interest rates go up by a substantial but rational amount.
- If the government doesn’t unwind their programs until after inflation becomes an issue, then we’re going to see the entire interest rate market get hammered and we’re going to see the Fed have to raise short term rates a LOT higher than they would if they have a reasoned and proactive approach to it. This in turn will put a LOT of upward pressure on mortgage rates and I expect we’ll see rates that will make us long for the days of 6 and 7% rates again.
Let’s face a couple of realities of the markets:
- Money can’t stay “free” forever. Rates are going to go up – the only question is by how much.
- When someone borrows money, they eventually have to pay it back.
- The greater the risk of inflation, the higher the rates are going to be.
- The more proactive the government is fighting inflation, the lower rates are going to be.
Fed Can’t Wait Too Long for Policy Shift: Volcker – General * US * News * Story – CNBC.com
The enormous amounts of liquidity pumped into the U.S. financial system by the Federal Reserve are not inflationary “at the moment” but will become so at some point, Paul Volcker, the former Fed chairman and a White House adviser, said on Thursday.
Volcker, now an economic adviser to President Barack Obama, said it was difficult, but necessary, to start draining the billions of dollars in liquidity even while unemployment rates remained high as the U.S. battles out of recession.
“You have to act against what seems like common sense. If you wait, it’s too late,” Volcker said while answering questions after a speech on financial markets at Harvard University’s Kennedy School of Government.
Volcker is best known for bringing down raging inflation in the United States after he was appointed Fed chairman in 1979 — chiefly by pushing the federal funds rate, the central bank’s key policy tool, to a peak of 20 percent in 1981.
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