Straight Story: Interest Rates

Marketplace Staff Aug 11, 2006

TEXT OF INTERVIEW

KAI RYSSDAL: It is time once again for our economics editor, Chris Farrell, to help you sort out what is smart, what is stupid and what’s the Straight Story. This week, Chris, some thoughts on a puzzling pause.

CHRIS FARRELL: OK, Kai, here’s what we know. To no one’s surprise, the fed voted to take a break from its two-year long campaign to raise interest rates.

RYSSDAL: Yes.

FARRELL: And your good friend, Chairman Ben Bernanke. . .

RYSSDAL: My good friend, that’s right.

FARRELL: Yes. He said a slowing economy and prospects for lower inflation rates justified it. Problem is, reactions are all over the lot. Let me just give you a few of the most popular.

RYSSDAL: All right.

FARRELL: A, the fed made a terrible mistake. Now inflation is going to take off. Or B, the fed tightened too much. The economy is sinking into recession. Or C, ha, we’ve got the worst of both worlds; rising inflation and slowing growth. Or D, come on, Ben’s one of the best economists around. He knows what he’s doing. So, which side is right? Here’s the straight story: We don’t know yet, and we won’t until we see what happens to the housing market.

RYSSDAL: OK, wait. What? Housing?

FARRELL: Housing.

RYSSDAL: Housing?

FARRELL: If the housing market was a bubble, and that bubble burst and prices declined sharply, we are sinking into recession. And there’s lots of economists who are pouring over the data and they’re finding some convincing evidence and in some markets the published price declines, or not quite accurate because builders are putting in all kinds benefits and bennies. Now, on the other side, if you’re in my camp, and I would call it the Ben Bernanke camp. So I’m a Ben Bernanke follower.

RYSSDAL: You and Ben, right OK.

FARRELL: Me and Ben, all right. I think instead of a bubble popping, we’re going to have a nice slow leak, slow leak. Yes, prices are going to decline a little bit. In some markets, they may go down a little bit more. Consumers are going to retreat a bit. They’re not going to use their houses as an ATM machine. Slower growth, but no recession.

RYSSDAL: Okay, let me add to the slow leak another thing you’ve been hearing a lot with the Federal Reserve; slow landing. They want to engineer a slow landing. Do you think they’re going to be able to do it? Or, are we going to thump down hard and wind up in a recession?

FARRELL: Martin Feldstein, great economist, Harvard University, head of the National Bureau of Economic Research, wrote an editorial in The Wall Street Journal. And he argued that it’s almost impossible to do a soft landing. Again, I come back to the housing market. If the housing market has a soft landing, this economy has a soft landing. If the housing market has a hard landing, this economy has a hard landing.

RYSSDAL: All right. What does that mean for you and me and everybody else who’s listening to us, and our investments?

FARRELL: Well, there’s a couple things. Now, I’m in the optimistic camp.

RYSSDAL: Okay.

FARRELL: I think globalization survived. I think this economy continues to grow. I think we’re going to skirt recession. So the strategy that I like is to continue to invest in equities, but you may want to put the ‘what if Chris Farrell is really wrong’ portion of your portfolio into treasury bills; a big dollop of treasury bills to hedge yourself against trouble. I think there’s one other investment implication. It comes from Bill Groves.

RYSSDAL: He’s the bond guy, yes.

FARRELL: The Warren Buffett of the bond market. He says, look, there’s this discussion about recession, no recession. False choice. No matter what, the economy is slowing down. What does that mean? Bonds. Now, he’s not worried about inflation. He thinks the inflation paranoia is way exaggerated and he’s recommending the bond market. He thinks that this may be the last gas of the bond market; the last great bull market in the bond market, but he makes a pretty convincing case that there’s real value in bonds.

RYSSDAL: All right. One more thing before I let you go, Chris. It’s a little bit of a technical point, but it might mean something, so I want to bring it up. There was, at this fed meeting on Tuesday, a dissenting vote on whether or not to stop raising interest rates. It’s a pretty rate thing. It’s pretty rate that it become this public. Does that reflect, in any way, dissatisfaction over Bernanke or the fact that rates might go up the next time they meet in September? I mean what does it mean?

FARRELL: What it does reflect is Bernanke is new. What fed chairman like are unanimous votes because it shows that they’re powerful. And Greenspan, you know, he maneuvered to make sure that there was a unanimous vote. I can’t get too excited about it. If this becomes something under the Bernanke fed that we see again and again, then we have a very weak chairman, and I would be worried. At this juncture in the economy where good people can really have strong disagreements about where this economy is going, I think it’s okay. And actually from Bernanke’s perspective, from the perspective of the central bank, if you’re going to have a dissenting vote, that was actually the right one to take.

RYSSDAL: All right. The Straight Story from our man, Chris Farrell. Thank you, Chris.

FARRELL: Thanks a lot.

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