Zero

December 17th, 2008

That’s the new target interest rate announced by the US Federal Reserve today (with a margin of up to 25 basis points). It’s also, following the $50 billion Madoff fraud and the increasingly widespread suspicion that the entire bailout scheme has been operated to promote the interests of Goldman Sachs at the expense of its competitors and the general public, an upper bound for the credibility of the global financial system. And it’s a pretty good estimate of the probability that we’re going to avoid a recession worse than any since the Great Depression.

Without a household name like Citigroup or GS going bust, it’s hard to convey the seriousness of the latest news in an environment where we are already inured to financial cataclysms. But it seems pretty clear that the last couple of days spell the end for both hedge funds (many of which have lost a fortune with Madoff and all of which are subject to invidious comparisons with his decades-long Ponzi scheme) and money market funds, which can’t possibly cover their costs while paying positive net returns, given a funds rate of 0.25 per cent.

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  1. Uncle Milton
    December 17th, 2008 at 17:42 | #1

    I don’t see why cuts to the Fed funds rate should affect the margins earned by the money market funds — the interest rates they pay and are paid should go down by the same amount. So why then are they unable to cover their costs?

  2. John Quiggin
    December 17th, 2008 at 17:55 | #2

    As noted in the link, the amount they pay, after charges, has gone below zero. At this point check accounts, not to mention mattresses, look like a more appealing investment. I’ll amend the post to clarify this.

  3. Ikonoclast
    December 17th, 2008 at 19:18 | #3

    After the Yen carry trade will we have the US dollar carry trade? What implications will that have for the world economy?

    I notice the new Bond movie has the villain demanding payment in Euros and making a slighting aside about the US dollar. Good for a laugh. Looking forward, will the Euro and the Yuan be the key world currencies?

  4. TerjeP
    December 17th, 2008 at 19:54 | #4

    If the US dollar is deflating then 0% interest may still be too high to halt deflation (which was exactly the problem Japan had a few years back). However you can’t cut nominal interest rate targets below 0% which is one more reason to abandon interest rate targeting entirely. It is time we moved back to targeting commodity prices. In particular the commodity that is metalic and monetary.

  5. GreekAmongRomans
    December 17th, 2008 at 20:26 | #5

    Anecdotally, it appear that the U.S. may be intervening in the forex market to engineer a currency depreciation; protectionism by another name. As a side effect, they are also exporting deflation to the other economies. However, the other economies may not allow great readjustments. The Chinese as well as the EU will likely not allow it.

  6. carbonsink
    December 17th, 2008 at 22:07 | #6

    Man, that is one dark post Prof Q.

    IMO, we’re living through a highly delusional period in Australia’s history. The news out of China is almost as bad as the US, but we’re still partying like resources boom hasn’t ended. I’d really like to know what Bill Evans is smoking. That must be some good sh*t.

    Oh, and great to see you linking to Calculated Risk. Such a great blog.

  7. Alanna
    December 17th, 2008 at 22:29 | #7

    I am not surprised at all by the Goldman Sachs competitive advantage with the bailout funds. Seriously what did we expect from the US financial system which has been allowed (and politically actively encouraged) to become dysfunctional with unprecedented levels of deregulation which led to unprecedented levels of dishonesty and unprecedented levels of obscene greed at the very highest levels of management. It was only natural the bail out funds would fall into the same black hole. I also think the US will be the first to abandon free markets in the form of a currency depreciation and elsewhere. Their trade deficit is a monster.

  8. TerjeP (say tay-a)
    December 18th, 2008 at 07:42 | #8

    “Anecdotally, it appear that the U.S. may be intervening in the forex market to engineer a currency depreciation; protectionism by another name.”

    Bollocks!! If your currency is undergoing deflation then a direct intervention in currency markets is the one sure method of averting problems. I don’t see how people can simultaneously hold the view that that currency market interventions are somehow distortionary whilst open market operations conducted full time to pervert interest rates are somehow natural. If you impose a fiat currency onto society then you have a duty to manage and stabalise the value of that currency.

    We never should have had the rapid run up in commodity prices and we should not now be having a run down in commodity prices. The US dollar if properly managed would not exhibit either extremity. If they are deciding at last to manage their currency then we should cheer rather than jeer.

  9. Socrates
    December 18th, 2008 at 09:00 | #9

    I am also happy to see them manage their currency. The currency market seems confused and nervous. Rational direction should be given to it.

    Of course, I feel much disgust at the whole competence myth of the ex-Goldman Sachs “alumni” coming crashing down. it is not a university! They are not alumni of anything. They are just the best salesmen in their market. It was a blatant conflict of interest to appoint people like Paulsen, however smart. Rules on conflitct of interest in government appointments are there for a reason. We need people to reign these cowboys in, not bail them out. How does a Paulson decide to recommend prosecution of his former colleagues, if he finds evidence of fraud?

  10. Joseph Clark
    December 18th, 2008 at 11:14 | #10

    “I don’t see how people can simultaneously hold the view that that currency market interventions are somehow distortionary whilst open market operations conducted full time to pervert interest rates are somehow natural.”

    Good point Terje, but it is possible to believe that both are bad. I don’t see how people who see the evil of interest rate targeting can be OK with currency targeting.

  11. Nettle
    December 18th, 2008 at 11:20 | #11

    Is the US turning into a toxic asset?

  12. December 18th, 2008 at 11:45 | #12

    Joseph,
    I think you must have missed the last sentence in that paragraph of Terje’s comment for you to misunderstand his comment.

  13. O6
    December 18th, 2008 at 12:06 | #13

    Can the US manage its currency, given its level of debt and the huge budget deficit? If it can, how?

  14. smiths
    December 18th, 2008 at 12:14 | #14

    for a little coincidence quirk …

    check out the top two banking contributers to the prezelect, and check out the surviving banks in the us at the moment,

    just one of those things

  15. December 18th, 2008 at 12:26 | #15

    smiths,
    Got a link? I would be interested.

  16. smiths
    December 18th, 2008 at 12:35 | #16

    ok, but i dont know how to trim down links so sorry for this

    top two american banks, goldman sachs and jp morgan

    http://www.opensecrets.org/pres08/contrib.php?id=N00009638&cycle=2008

  17. December 18th, 2008 at 12:40 | #17

    UBS in there as well – another beneficiary of largesse. Citigroup next down is interesting, but it has far more employees in the US than Goldmans.
    Lehman and Morgan are there too, with Lehman bringing up the rear. Obviously did not give enough.

  18. GreekAmongRomans
    December 18th, 2008 at 13:44 | #18

    TerjeP@7

    What are you on about?

    What do you mean the U.S. currency is deflating; the terms depreciation or devaluation are the appropriate terms to use when discussing currency adjustments, not deflation– blimey!

    TerjeP, for your benefit, it appears that we need to perform a bit of knowledge transfer.

    Devaluation – is a reduction in the value of a currency with respect to other monetary units.

    Depreciation – is used for the unofficial decrease of the exchange rate in a floating exchange rate system.

    The U.S. currency is being depreciated.

    “If you impose a fiat currency onto society then you have a duty to manage and stabalise the value of that currency.”

    Bollocks back! What one should or should not do is not the point, what is relevant is what is being done is likely to be done. I prefer to focus on reality.

    TerjeP, and before you get on your high horse, I’ll recommend some bedtime reading for you, care of the Federal Reserve titled Monetary Policy When the Nominal Short-Term Interest Rate is Zero. http://www.federalreserve.gov/pubs/feds/2000/200051/200051pap.pdf

    Low and behold in the white paper there is a section titled Policy Actions in Foreign Exchange. Have a read and then we can discuss.

  19. GreekAmongRomans
    December 18th, 2008 at 14:13 | #19

    One further point, with the U.S. currency looking a little shaky we might see the Obama equivalent of Jimmy Carters, Carter Bonds when Obama takes office. The Japanese are likely going to come to the rescue of the U.S., by backing the U.S. to issue U.S. treasury paper denominated in Yen. This will assist both Japan and the U.S.

  20. TerjeP (say tay-a)
    December 18th, 2008 at 17:00 | #20

    “Can the US manage its currency, given its level of debt and the huge budget deficit? If it can, how?”

    O6 – you bet they can.

    If they want the dollar to go up in value they just need to sell Federal Reserve assets in exchange for dollars. The dollars will appreciate accordingly. The assets they sell might be foreign reserves, bonds or gold. It doesn’t matter much as long as the net effect it that they demand dollars.

    If they want the dollar to go down in value they buy assets using printed cash.

    If they abandoned their fetish with fixing interest rates and made a clear statement of commitment to a given exchange rate (with gold or with some commodity index or perhaps even the Euro) they would also have a large pool of speculators on their side 99% of the time.

    It is easy to do. Hong Kong does it. Denmark does it. Bulgaria does it. The USA could do it.

  21. TerjeP (say tay-a)
    December 18th, 2008 at 17:04 | #21


    “Devaluation – is a reduction in the value of a currency with respect to other monetary units.

    Depreciation – is used for the unofficial decrease of the exchange rate in a floating exchange rate system.”

    The exchange rate is the value of a currency with respect to other monetary units. So I am baffled by your attempt at drawing a distinction.

    I read section 5 of your linked document. It wasn’t the best use of my time and I don’t know why you sent me there.

  22. TerjeP (say tay-a)
    December 18th, 2008 at 17:10 | #22

    What do you mean the U.S. currency is deflating; the terms depreciation or devaluation are the appropriate terms to use when discussing currency adjustments, not deflation– blimey!

    Deflation equates to an appreciation of a currencies value. Inflation equates to depreciation of it’s value. Deflation and Inflation are typically with reference to domestic measures of value and appreciation and depreciation with respect to external measures of value. However it is not as if they are separate phenomena.

  23. GreekAmongRomans
    December 18th, 2008 at 17:42 | #23

    “The exchange rate is the value of a currency with respect to other monetary units. So I am baffled by your attempt at drawing a distinction.”

    Deflation in economic parlance infers the *sustained* fall in prices of goods and services.

    In general, if one intends genuine discourse then the preciseness of language or thought is a must– it avoids confusion. Need I say more?

    “I read section 5 of your linked document. It wasn’t the best use of my time and I don’t know why you sent me there.”

    It outlines the policies that the Federal Reserve is prepared to undertake under zirp environment; I would have thought that would have been self evident– yes… no…?

    I’m sensing a touch of the tin foil hat brigade in you TerjeP.

  24. Michael of Summer Hill
    December 18th, 2008 at 18:02 | #24

    John, it seems like 49 year old David Friehling an accountant from ‘Friehling & Horowitz’ has decided to shoot through. The auditor is now under criminal investigation and being sought in relation to the fraud committed by Bernard Madoff.

  25. GreekAmongRomans
    December 18th, 2008 at 23:43 | #25

    Joseph Clark@10

    Totally agreed.

    TerjeP@8
    “We never should have had the rapid run up in commodity prices and we should not now be having a run down in commodity prices.”

    The above, is a direct consequence of the United States profligate lifestyle/policies, which has secured it the formidable shackle of debt. They ignored or neglected the fact that the nation that holds the reserve currency must also demonstrate providence.

  26. GreekAmongRomans
    December 19th, 2008 at 00:32 | #26

    For parties interested in the the Madoff scam the following article exposes that the absolute incompetency of the SEC; they had been informed about this way back in 2000.

    http://clusterstock.alleyinsider.com/2008/12/busting-bernie-madoff-one-mans-10-year-crusade

    The article begins with:

    The Wall Street Journal has published a detailed account of private fraud investigator Harry Markopolos’s efforts over the past 10 years to persuade the SEC that Bernie Madoff was running a gigantic Ponzi scheme (or, at best, was front-running).

    Markopolos submitted extensive analysis to the SEC in 2005, which we’ve embedded below. The SEC did conduct an investigation thereafter, in the course of which Bernie Madoff “mislead” them about the nature of some of his dealings with his primary fund-of-funds promoter Fairfield Greenwich Group.

  27. stevebea
    December 19th, 2008 at 02:31 | #27

    Finally a use for Gitmo that all can agree on–put the incompetent SEC regulators there, oh and Hank Paulson, Barney Frank and Chris Dodd, R Holder Mr Obama’s new AG, any one who made money from their time at Fannie and Freddie, the people who gave GWB an MBA from Harvard, Janet Reno for threatening banks who did not extend credit to people in the US to buy a house for which they had no business getting a mortgage, the people who created the ultimate weapon of mass destruction the derivative SWAP(Soiled WorthlessAssPaper) Next, hang Madoff from one of the flag poles on the NASDAQ.
    And Remember: If you stacked all the economists in the world head to toe from here to the moon… you’d be doing the world a favor: most would die from the fall to earth and the rest would float off into the abyss of space.

    /facts are stubborn things- John Adams

  28. TerjeP (say tay-a)
    December 19th, 2008 at 17:38 | #28

    In general, if one intends genuine discourse then the preciseness of language or thought is a must– it avoids confusion. Need I say more?

    Well you could start by explaining how your attempt at clarification (which I quoted in comment 21) entails any precision what so ever. It seem to me like a rather imprecise distinction.

  29. GreekAmongRomans
    December 19th, 2008 at 18:01 | #29

    TerjeP@28

    hmm…. double-think

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