The Test

I picked this up via Eschaton.

Stephen Roach, of Morgan Stanley, writes that The Test for the US Federal Reserve is to keep US Capitalism functioning despite heading for one of its periodic crises

... Lacking in support from labor income generation, America’s high-consumption economy has turned to asset markets as never before to sustain both spending and saving. And yet asset markets and the wealth creation they foster have long been balanced on the head of the pin of extraordinarily low real interest rates. The Fed is the architect of this New Economy, and most other central banks -- especially those in Japan and China -- have gone along for the ride. Lacking in domestic demand, Asia’s externally led economies know full well what’s at stake if the asset-dependent American consumer ever caves. And so they recycle their massive build-up of foreign exchange reserves into dollar-denominated assets, thereby subsidizing US rates, propping up asset markets, and keeping the magic alive for the overextended American consumer.

In other words, people are borrowing against their appreciation of assets and spending like crazy.

It didn’t have to be this way. The big mistake, in my view, came when the Fed condoned the equity bubble in the late 1990s. It has been playing post-bubble defense ever since, fostering an unusually low real interest rate climate that has led to one bubble after another. And that has given rise to the real monster -- the asset-dependent American consumer and a co-dependent global economy that can’t live without excess US consumption. The real test was always the exit strategy.

The message is the same for anyone who invests in a pyramid selling scheme (of which home ownership is the prime example): when you run out of suckers, the whole scheme collaspes.