Fed Raises Key Rate

As expected the Federal Reserve Board raised short term rates today to 5%. That’s up from 4.75% and is the highest for quite a while. The New York Times reports today’s rate hike here: Fed Raises Key Rate to Highest Level in 5 Years

The reason rates are rising is that the economy still is performing well: GDP grew nearly 5% at the start of the year, and when it slows during the second half it will still likely be in the 3% range. This is strong growth. In these circumstances the Fed has to be concerned about inflation picking up, which it tends to do when economies grow that well for any length of time. Hence the effort to slow things a bit by raising rates.

Uncommented on though is a more insidious rate increase: long term rates have been creeping up slightly lately because worldwide conditions in the credit markets have tightened. One reason that long term rates were low, by historical standards, for the past decade was the excessive savings rate in many countries other than America. This excess of savings enabled America to run huge deficits because it could purchase the money abroad to offset its lack of domestic savings. There was no external discipline forcing America toward fiscal responsibility. This comfortable scenario now appears to be ending. The Japanese and European economies are all growing again which is keeping some of the savings previously available to America off the international market.

In other words there are now alternatives for investors that weren’t there a few years ago. So America now has to bid more aggressively for money, and that is driving long term rates up. In short: US long term rates are being set not in Washington, but on the world market for credit creating a dependency that Americans are not used to.

So even if the Fed wants to keep rates where they are it may not be able to because the disastrous fiscal polcies of the Bush era have forced America to rely on foreign investors. As a direct result of this US mortgage rates are more dependent on what Japanese, European, and Chinese government policies are than they are on American policies.

Just another consequence of the incompetence of Bush.