Interest rates high enough

By John Tsitrian, Special to the Journal | Monday, April 17, 2006

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Overall, we just closed out a pretty decent first quarter for the U.S. economy — with me taking some special satisfaction by the fact that the post-Katrina doom-and-gloomers and hand-wringers were utterly repudiated by the economy’s performance data on just about every measurable front.

That was only reinforced by Federal Reserve Board chairman Ben Bernanke’s comment last week, saying that the U.S. economy “rebounded strongly” from its fourth quarter doldrums of last year during the three months that just ended.

Despite the many dips and slowdowns that are a part of every cycle, in the long run, it doesn’t pay to be a pessimist about the American economy, as the tough news backdrop of the past couple of years have demonstrated. Given the war, given rising energy costs, and given devastating natural disasters, you’d think the economy would be in tatters by now. But resilience has always been the watchword of the United States, and the steady to slightly-better-than-average economic growth rates of the past few years have only underscored the point.

In fact, in Bernanke’s view, the economy still has the potential for “overheating,” or growing so rapidly that price pressures on labor and raw commodities will spill over into a generalized inflation, which has traditionally been the bugaboo of the Federal Reserve Board. Bernanke continued the determined plan of his predecessor, Alan Greenspan, to hold inflation in check by slowing down growth a bit.

He’s using the only real tool that the Federal Reserve Board has at its disposal — the setting of a key interest rate known as the federal funds rate. Banks have to borrow money at that rate, so when it rises, they pass the increased cost of money on to their customers by raising rates that they charge for lending money. In short, business and consumer borrowers have to pay higher interest rates on new loans and on previously borrowed money subject to variable rate increases. If there’s an operative word for this, it’s “ouch.”

And as every variable-rate borrower knows, there has been an extended series of “ouches” during the past several years, when the Fed started its current cycle of interest-rate increases. Like other business people, I don’t like to see money costs go up, but considering the low baseline of rates that were in place when the Fed began this up-cycle, the upside move has probably been a good idea.

For one thing, economic growth hasn’t been squelched. For another, inflation has been held in check. And for still another — and possibly the most important — it has given the Fed some breathing room if the economy does, indeed, slow down and rate reductions are needed to jump-start it. You can’t take interest rates much lower than the 1 percent federal funds rate of 2001 — so it was a somewhat precarious situation for the Fed, having virtually no monetary policy tool to use if the economy went into the tank. That seemed like a distinct possibility considering the turbulence of that year and the quarters that followed it.

My hope now is that the Fed, with a comfy cushion in place, will stop this rate-raising trend — some of which I believe is Bernanke’s way of giving a signal that he intends to be as tough on inflation as Greenspan was. I’m all for that, but his macho point has been made. Considering that new home sales have been tapering off in recent months, it seems clear that the housing market has finally responded to the higher rates.

For this part of the country, the lower price levels that the cattle market has been enduring since the end of last year are probably a signal that consumer demand for higher-priced cuts of beef has also been tapering off — and like other borrowers, cattle producers have had to pay up for their capital needs, only squeezing their margins as lower prices for finished cattle crunch down on the higher cost of producing them.

As for the tourism industry, I know firsthand how much it’s been affected by higher gasoline costs in recent summers, so a sense that the interest rate cycle is topping out would be welcome not only from the business side, but also from the consumer side. We’ve seen soft numbers of visitors in 2004 and 2005, so some relief on credit card and mortgage credit line interest rates would be a nice economic shot in the arm for the traveling public, which is still trying to absorb the shock of high energy costs.

John Tsitrian is a former member of the Chicago Options Exchange and a Black Hills resident. His business column appears biweekly in the Sunday Journal.