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Measuring National Happiness
Libor or NYbor?
reported by WSJ.
The troubles of banks in Europe are pushing up an interest rate widely used in the U.S., prompting the idea of a U.S.-based alternative to that rate, known as the London interbank offered rate, or Libor.
![[Chart]](https://s.wsj.net/public/resources/images/MI-AQ041_LIBOR_20080422185623.gif)
The problem: Payments on trillions of dollars in U.S. corporate and mortgage loans are set according to dollar Libor, but only three of the 16 banks that contribute their borrowing costs to calculate the rate are based in the U.S. That means the financial difficulties of European banks are having an outsized effect on U.S. borrowing costs, and could complicate the Federal Reserve's efforts to bring those borrowing costs down.
European banks' "demand for dollar funding is likely to raise dollar Libor and result in higher borrowing costs for everyone from [General Electric Co.] to the average homeowner, even as the Fed is lowering the fed-funds rate further," says Scott Peng, an interest-rate strategist at Citigroup Inc. In a recent report, Mr. Peng proposed the creation of a "NYbor" index, which would track the borrowing costs of U.S. banks only.
A significant gap between borrowing rates reported by European and U.S. banks has opened up since last week, when many banks started raising their reported Libor rates. The banks' moves came as the British Bankers' Association, which oversees Libor, said it was investigating bankers' concerns that their rivals were understating their actual borrowing costs to avoid looking desperate for cash.
John Ewan, who manages the Libor program at the BBA, said Tuesday the association's Foreign Exchange and Money Market committee is reviewing the way Libor is calculated.
On Friday, the gap between three-month dollar Libor and the average three-month borrowing rates for U.S. banks in the 16-bank Libor dollar panel reached 0.04 percentage point, its highest level since the financial crisis began in August. If sustained, that would represent an added $2.8 billion in annual interest costs on some $6.9 trillion in U.S. corporate and subprime-mortgage debt tied to Libor. It has since fallen, but analysts said it ultimately could increase to 0.10 percentage point as European banks' difficulties become fully reflected in their Libor quotes.
Analysts attribute the sharper rise in European banks' borrowing rates to the fact that they're scrambling for dollars to pay off dollar-denominated debts. Pressure is particularly acute in Europe in part because it lacks analogs to such U.S. institutions as Fannie Mae, Freddie Mac and the Federal Home Loan Banks, which provide U.S. banks with access to additional funding.
Wasserstein: What We’ve Learned From the Market Mess
inflation indexed capital gain tax
When inflation is rising, the effective capital gain tax also rises, which hurts investment and economy. Here is a piece from WSJ advocating inflation indexed capital gain tax.
![[The Inflation Threat to Capital Formation]](https://s.wsj.net/public/resources/images/ED-AH336C_darda_20080409172415.gif)
An update on debate over trade and wage inequality
Economist analyzes Paul Krugman’s recent paper on trade and wage inequality:
Krugamn, “It’s no longer safe to assert that trade’s impact on the income distribution in wealthy countries is fairly minor…There’s a good case that it is big and getting bigger.” ….two reasons why. First, more of America’s trade is with poor countries, such as China. Second, the growing fragmentation of production means more tasks have become tradable, increasing the universe of labour-intensive jobs in which Chinese workers compete with Americans.
…
It is possible that globalisation is becoming a bigger cause of American wage inequality. But contrary to the tone of the political debate, and the thrust of Mr Krugman’s commentary, the evidence is inconclusive. “How can we quantify the actual effect of rising trade on wages?” Mr Krugman asked at the end of his paper. “The answer, given the current state of the data, is that we can’t.”
Bubble Burst in China
![[Stock Plunge]](https://s.wsj.net/public/resources/images/P1-AL266A_CSTOC_20080418230412.gif)
Battle of ideas is not over
Feldstein: Enough Interest Rate cuts
Enough With the Interest Rate Cuts
It's time for the Federal Reserve to stop reducing the federal funds rate, because the likely benefit is small compared to the potential damage.
Lower interest rates could raise the already high prices of energy and food, which are already triggering riots in developing countries. In order to offset the inflationary impact of higher imported commodity prices, central banks in those countries may raise interest rates. Such contractionary policies would reduce real incomes and exacerbate political instability.
The impact of low interest rates on commodity-price inflation is different from the traditional inflationary effect of easy money. The usual concern is that lowering interest rates stimulates economic activity to a point at which labor and product markets cause wages and prices to rise. That is unlikely to happen in the U.S. in the coming year. The general weakness of the economy will keep most wages and prices from rising more rapidly.
But high unemployment and low capacity utilization would not prevent lower interest rates from driving up commodity prices. Many factors have contributed to the recent rise in the prices of oil and food, especially the increased demand from China, India and other rapidly growing countries. Lower interest rates also add to the upward pressure on these commodity prices – by making it less costly for commodity investors and commodity speculators to hold larger inventories of oil and food grains.
Lower interest rates induce investors to add commodities to their portfolios. When rates are low, portfolio investors will bid up the prices of oil and other commodities to levels at which the expected future returns are in line with the lower rates.
An interest rate-induced rise in the price of oil also contributes indirectly to higher prices of food grains. It does so by making it profitable for farmers to devote more farm land to growing corn for ethanol. The resulting reduction in acreage devoted to producing food crops causes the supply of those commodities to decline and their prices to rise.
Rising food and energy prices can contribute significantly to the inflation rate and the cost of living in the U.S. The 25% weight of food and energy in the U.S. consumer price index means that a 10% rise in the prices of food and energy adds 2.5% to the overall price level. Commodity price inflation is of particular concern now that the CPI has increased 4% in the past 12 months. Surveys indicate that households are expecting a 4.8% rise in the coming year.
In lower-income, emerging-market countries, food and energy are generally a larger part of consumer spending. A rise in these commodity prices can therefore add proportionally more to the cost of living in those countries, and therefore depress real incomes to a greater extent than in the U.S.
Government actions to dilute these effects by increased subsidies on the prices of energy and food add to the government deficits, reducing the national saving available for investment in plant and equipment that would otherwise contribute to faster economic growth.
The rise in the U.S. inflation rate, and the adverse effects in emerging market countries, might be defensible if lower interest rates could significantly stimulate demand and reduce the risk of a deep recession. But under current conditions, reducing the federal funds interest rate from the current 2.25% by 50 or 75 basis points is not likely to do much to stimulate demand.
The current conditions in the housing industry and in credit markets mean that a further lowering of interest rates will have a smaller impact on demand than in previous recessions. In previous recessions, lower rates stimulated aggregate demand by inducing increased home building. But with the massive inventory of unsold homes – up 50% from a few years ago – a further cut in the fed funds rate would have little effect on housing construction.
Moreover, lowering the fed funds rate has not brought down mortgage interest rates. While the fed funds rate is down three percentage points from this time last year, mortgage interest rates are down by less than 0.5 percentage points.
The dysfunctional state of the credit market means that many individuals and businesses are unable to get credit. Lowering interest rates will not stimulate demand for those who cannot get credit.
Economic recovery will require resolving the difficult problems of the credit markets, dealing with the millions of homeowners who may now be tempted to default on mortgages that exceed the value of their homes, and reducing the risk that the ongoing decline in house prices will push millions of additional homeowners into a vulnerable, negative equity condition. A lower fed funds rate will not solve any of those problems.
Mr. Feldstein, chairman of the Council of Economic Advisers under President Reagan, is a professor at Harvard and a member of The Wall Street Journal's board of contributors.