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How Shall The US Save Its Economy?
Malaysia Perspective | 11 October 2010

By Yang Ming Wan

Most of the governments and central banks around the world will adopt the strategy of relaxing monetary and fiscal policies to stimulate the economy to counter every economic downturn or even recessions. This trick is often effective, and when the economy has bottomed out, central banks will then raise interest rates while governments will seek ways to reduce its budget deficits.

When the US subprime mortgage crisis began snowballing, the Federal Reserve (in effect the central bank of USA) started cutting interest rates from early 2007. Fed funds rate was cut from the 5% high in May 2006 to 4.25% in December 2007, and then rapidly tumbling to a historical low of between 0 – 0.25% by December 2008. Since the sub-prime crisis worsened and plunged the American economy into recession in 2009, the Federal Reserve Board adopted a quantitative easing of its monetary policy, which meant not only were business and consumer borrowing costs reduced to zero, it also started printing a tremendous amount of the green back in order to revive the economy. Since then, over the past year and a half, the federal funds rate has remained at a record low until now. In addition, the US government has also administered an economic stimulus package that amounted to US$787 billion in early 2009 to rescue the American economy from its deep recessional winter.

US Economy May Deteriorate Further
These initiatives did in fact lift the US economy out of recession. After the severe recession in the second half of 2008 through the first quarter of 2009, the US economy bottomed out in the third quarter of 2009 to register a 1.6% growth before powering on to 5% in the fourth quarter. However, good times never last, for the US economy began to soften in the second quarter this year, notching only 1.6% of year-on-year growth rate. Recently released economic data showed that the US economy is showing signs of duress. Consumer spending has slowed again, while after the expiry of the tax incentives in April this year, which was given by the US government to encourage Americans to buy houses, the property market started heading south again. At the same time, unemployment rate remained high at about 10%.

As a result, some well-known American economists are already urging the US Government to introduce another stimulus package to avert another recession. Other market experts called for the Fed to increase its quantitative policy easing. These proposals imply that the US government’s debt will either deepen or it will print more money. The problem is, are these the best prescriptions to resuscitate the US ailing economy?

Other experts believe that the Fed should not keep interest rates low for too long; they even believe a low interest rate is a double-edged sword, which might trigger yet another crisis. Economists in general cannot be sure whether it is a boon or bane to keep interest rates low for long. Moreover, the zero interest rate will prove too tempting to financial institutions, for after every economic downturn or market bubble, they can capitalise on the negligible interest rates to accumulate their capital and then hand out loans liberally.

Negative Impact Of Low Interest Rates On Consumers
Apart from that, in a world where debt is prevalent, low interest rates spell bad news especially for consumers, for lower borrowing costs will encourage them to spend recklessly. As of early June this year, US household debt has reached a mind-blowing US$1.17 trillion, and this may fuel yet another bubble crisis. Another danger of a zero interest rate is that companies are allowed to roll over their original non-performing loans, a practice known as “evergreen loans”, which may create so-called “zombie companies” that operate abnormally. Artificially propping up the property market to keep prices from falling may also incubate another crisis and prolong the suffering of Americans. For these reasons, experts are suggesting that Fed should raise interest rates as soon as possible to as high as 2%, so that real interest rate will no longer yield negative returns.

Take Japan as an example. It is one of the few countries in the world that had adopted a low interest rates policy to save its economy. Over the past 16 years, it has kept its interest rates perpetually at zero; since 1995, Japan’s benchmark interest rate has been hovering at a low of between 0.1 to 0.47%. Similarly, the Japanese government has also spent a lot of money to stimulate its economy, so much so that soon its government debt will amount to 200% of its GDP! Despite Japan’s zero interest rate policy and spending much money to save its economy, its efforts have yet to yield positive results.

Perhaps America should learn from Germany and Asia, to bite the bullet and allow the phoenix to burn before its rebirth. It should perhaps allow the economy and financial system to go through the painful process of adjustment, rather than resorting to print money and spend its way out of a recession. This also means that after we over-spend, we have to tighten our belts. We should not spend every penny earned, but we should squirrel part of our money away for rainy days. Though it is not easy to bear the pain of adjustments, and it will need some time to hammer out the details, I believe this is the only way the US economy can survive the crucible and emerge from the ashes with its economy reborn.

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