What’s up with the stock market? Can we have a bull market and a bear market in different sectors at the same time?
Question/Comment: What’s up with the stock market? I thought it was supposed to be a leading indicator of economic conditions. But over the last months, the market seems to respond more to interest rate levels in addition to insignificant economic news rather than to the gathering credit crunch, inflation risk and housing mess. Can we have a bull market and a bear market in different sectors at the same time?
Paul Solman: So let me get this straight, Connor. You think I know what’s up with the stock market? And still work for public TV? OK, get ready for a long answer. For what it’s worth (not much), here’s one basic way to look at the market’s overall price. At any given moment, it’s the value of all the future profits of the companies in it. That’s because when you buy a share in an S&P 500 index fund, say, you buy a tiny, tiny sliver of, roughly speaking, America’s top 500 companies. What are they worth collectively? You might think it’s their cash on hand, minus what they owe, plus what they can get for their buildings and machines – their “net worth,” in other words. But if they stop doing business, those machines might be almost worthless. A company’s value comes from lots of intangibles, not just the stuff it can lay claim to.
Ultimately, then, companies are profit generators – or at least they’re supposed to be. They’re worth whatever money the company can generate. Roughly, that is, their profits — which add up over time. To finally answer your question: yes, the market should be a leading indicator of future prosperity.
So why then does the market tend to go down when interest rates go up and vice versa? Several reasons. One is that when interest rates go down, those future profits are worth more today.
Think about it. You run a Mike’s Hard Lemonade stand and expect to earn $10 in profits this year, $10 next year, $10 for the next 10 years. What’s the stand worth right now? Or – another way of putting it – what might you or I be willing to pay for it? What should one pay for an income stream of $10 a year for a decade? $10 per year times 10 years. How about $100? Doesn’t seem too unfair, right? Pay $100, get $100.
But wait. Suppose interest rates are 5 percent a year. Then you could buy a bond paying 5 percent a year, which just means you’d lend someone the money at a 5 percent interest rate. So you’d get $5 a year for 10 years, plus your $100 back at the end. Your total payback? (Do the numbers before I tell you.) $150, right? READ MORE
I was surprised to hear that the Pabst brewery was razed. Do great American beers have any significant presence overseas?
Question/Comment: I was surprised to hear on your NewsHour piece that the Pabst brewery was razed. It made me think that in recent years a number of excellent American beers have been produced, some even better than highly touted foreign beers. Do these great American beers have any significant presence overseas?
Paul Solman: Depends what you mean by “significant presence.” The U.S. imports about $3.5 billion dollars worth of a beer a year, rising at a rate of something like 15 percent a year. We export some $200 million worth, mainly to Canada and Mexico, from both of which we import vastly more.
The rate of beer export growth was around 4 percent (2005-2006). The balance of beer is, in a word, negative. The hop gap is widening. Maybe a staggering dollar will reverse the trend.
Question/Comment: I was wondering if the “short supply chain” movement is also a movement into lean production techniques. I know that several companies (e.g., Toyota) have done it for years, but I was interested to know whether it has caught on.
Paul Solman: Lean production has indeed caught on. But in a sense, it caught on a long time ago. In fact, you could say lean production is the whole story behind the Industrial Revolution: making more with less. Every technological improvement (or productivity advance) in manufacturing is then an instance of lean production, from Henry Ford’s Model T assembly line to the “continuous improvement” movement made famous by the Japanese in the ’80s.
To the extent a short supply chain helps make more with less, it’s an aspect of productivity progress. In today’s terminology, that means “lean production.” READ MORE
Question/Comment: Last month, the stock market dived about 380 points in one day, then recovered the same day. That same day, the Fed lowered its rate .5 percent. Now I just heard it’s lowering its rate for the first time in many months. Obviously we’re talking about two different rates. What are they? And what’s the difference?
Paul Solman: The “discount rate” is what the Fed charges banks for loans they take; usually overnight to cover obligations they’ve got to OTHER banks or financial institutions. But the Fed can lend the money out for longer periods – say, 30 days. That can get banks over the hump when markets panic, and it’s why the Fed DID “open the discount window” by freely lending to banks for longer periods recently. It’s also “lowered the discount rate” to make it CHEAPER for banks to borrow.
The rate you hear more about is the FED FUNDS rate. That’s the rate banks charge each other for overnight borrowing. Since many other interest rates throughout the economy are pegged to the Fed Funds rate, lowering it or tightening it tends to goose or restrain the economy.
In our “explainer,” the punch bowl analogy applies to the Fed Funds rate. The emergency measures taken during the global market panic involved the “discount” rate. So the Fed lowered the discount rate without warning in a pinch; it lowered the Fed Funds rate at its regular every-6-weeks meeting. But then it also lowered the discount rate, since they never move very far from one another. READ MORE
Question/Comment: Why all the focus on just Fed policy? I’m with Alan Greenspan on also looking at our fiscal policy. Just lowering interest rates without raising revenues could just lead to more inflation. Thank you.
Paul Solman: What Robert is saying here is worth thinking about. The WAY the Fed lowers interest rates is by injecting the Fed’s money into the banking system and the Fed’s money is as good as…I was going to write “gold,” but of course the U.S. went off the “gold standard” in the 1930s and stopped promising to give you gold for your “Federal reserve notes” (take a break to look at the words above George Washington’s head on the dollar bill for a minute).
If there’s more money in the economy – “ceteris paribus” – why, the money will be worth less. That’s inflation. READ MORE
I’d like to know more about Fed — and how it is neither a federal agency, nor does it have any reserves.
Question/Comment: I’ve seen now several of your segments on the Federal Reserve and I encourage you, on your next segment, to go deeper. There is much information available regarding the Fed and how it is neither a federal agency, nor does it have any reserves. Our entire economy, as I’m sure you’re aware, is a house of cards built upon the mechanism of the Fed generating money literally out of thin air (with no tangible backing), distributed out to the federal reserve banks, trickling all the way down to us folks. Our fractional reserve banking laws allow our banks to lend out many times the amount of money they actually have in reserves. There is so much that is truly fascinating about this story but I’ve never heard it discussed or mentioned in the mainstream media. If you haven’t already read it, “The Creature from Jekyll Island” by G. Edward Griffin is a wonderful book (whether or not one agrees with the author’s political views).
Paul Solman: The “reserves” are what the banks keep with the Fed, not what the Fed stores somewhere else. On Jekyll Island, say.
Yes, the Fed creates money out of thin air, as you put it. And yes, the money tends to lose value over time, as more of it gets created than the values of goods and services multiplies. The problem is the ALTERNATIVE. As the Great Depression seemed to convincingly demonstrate, when the value of money SHRINKS, very bad things can happen to a moderately-free market economy like ours. It’s a little hard to see how our economy would grow if there was no fractional banking, and thus no supervised, intermediated credit.
So the Fed tries to steer its famous middle course between creating too much money and creating too little. And we haven’t had a Great Depression for 70-plus years, or a hyperinflation, for that matter. Not bad. READ MORE
What will make the LIBOR rate come down and what indicators should we look for to make it go down to “normal” levels?
Question/Comment: Mr. Solman: You are one of those few who makes economics as interesting as Paris Hilton’s love life (just kidding!) to the ordinary American. The LIBOR rate is higher than the 15-year mortgage rate right now. What will make it come down and what indicators should we look for to make it go down to “normal” levels? Thank you.
Paul Solman: Thank you for the Paris Hilton comparison, Maya, though America begs to differ. Enter “Paris Hilton” on YouTube and the first three videos have 77,000, 9.8 million, and 1.9 million views respectively. Enter my name, and you get 1961, 7441 and 559. Of course, mine are NewsHour segments, and tend to be a little short on skin.
As to LIBOR, it’s the “London Interbank Offered Rate,” the international rate charged by one bank to another for lending money (in London, obviously), as Maya clearly knows. There are different LIBORs for different lengths of time – one month, three month, six month, one year. Right now, though, all are LOWER than a 15-year mortgage in the U.S. Presumably, that’s because short-term interest rates have dropped, due to the Fed’s initiative, but long-term rates have NOT. Presumably, THAT’S because there’s now an expectation of greater inflation in the future, because the Fed’s creating more money. There are other factors too, though. But just at the moment, I think neither of us may have time for them.
Question/Comment: Housing prices skyrocketed to double in 3 years and everyone thought they were rich, and went out and spent the money. Now the market corrects 30 percent and everyone discovers that it wasn’t real. Why should the taxpayers bailout the major lending institutions due to poor lending practices? Why should the tax payers bail out the home owners that purchased way more than they could afford?
Paul Solman: Because if there’s a major meltdown in the financial markets, that hurts taxpayers too. Hurts us all a lot. In the ’30s, the Fed DIDN’T bail out some lending institutions because they thought they were failing “due to poor lending practices.” The Great Depression ensued. Maybe for that very reason. READ MORE
Question/Comment: As a long time observer of the mortgage market, particularly the subprime segment, I have been anticipating the current economic crunch for some time. Accordingly, I have been keeping a large amount of my savings ($85K) in an FDIC insured money market account that is currently earning 5.25 percent. Now that it appears rates will be dropping, where is the best place to keep the bulk of these funds? (Besides under my mattress, that is.)
Paul Solman: I wouldn’t recommend the mattress. I don’t know about San Diego, but those bedbugs now infesting New York City may eat currency.
“The best place”? If you mean safest, there are US-government I-bonds. You can buy up to $30,000 worth per family member per year, and they guarantee an interest rate of the CPI plus a premium, which is currently 1.3 percent. With a 1.21 percent inflation rate, the yield is only 2.51 percent at the moment. It’s reset every 6 months, and will be again Nov. 1. The real appeal is that if you don’t take the money out for six months, I think it is, your interest accrues tax-free, until you withdraw the money. The government has more information here.
Another similar option is TIPS. Read about, even buy them, here. Basically, they’re a longer-term version of an I-Bond, and as a result, the non-inflation-protected part of interest rate (the “premium”) is generally higher. READ MORE
When can we expect to break even, or at least recover some of the value that we lost due to the declining real-estate market?
Question/Comment: Everyone mentions all of those unfortunate people who are defaulting on their home loans due to the sluggish economy. Nobody mentions, however, the many hardworking Americans who saved and struggled to buy their dream homes and they are now in the difficult situation of paying for a home that no longer is worth what they paid for. It’s very frustrating to see your neighbors selling their identical homes for 5-10 percent less than what you paid for. Can these small interest rate cuts help us out? When can we reasonable expect to break even, or at least recover some of the value that we lost due to the declining real-estate market? Thank you.
Paul Solman: When you “break even” depends mainly on when you bought, no? If it’s in the past few years, yes, you’ve got a problem, since it looks like you bought at the peak (at least in most housing markets). Yes, a small interest rate cut CAN help. One of the insights of economics is that things happen “on the margin.” One implication is that little differences influence a lot of people. Think about how hard people look for “better-than-average” returns on their investments. Or bargains on their mortgages. Moreover, the half-a-percent (.5 percent) by which the Fed lowered short-term rates isn’t small. The rate dropped from 5.25 percent to 4.75 percent, right? What’s .5 as a percentage of 5.25? About a TENTH. That’s a big difference.