Conference nyoss1::market_investing

    	Do interest rates control inflation ? No, not alone.  But, interest
    rates are the one tool the Fed has available to try to influence the
    direction.  I guess another tool might be the reserve requirement for
    banks.
    
    	There are examples, in recent memory, where raising interest rates
    has reduced inflation, or where lowering interest rates has stimulated
    demand.  However, there are many other factors that determine the
    direction of inflation.
    
    	The reserve requirement is the amount that banks must keep on
    reserve and cannot loan out.  As an example, if the reserve requirement
    is 3%, then the bank could potentially loan out an amount equal to 97%
    of its deposits.  This reserve requirement effects the "creation" of
    money.  The higher the reserve requirement the less money that can be
    created.  The interest rates determine how much, if any, consumers want
    of the newly created money.
    
    	It seems to me that these tried and true economic methods should be
    of weakening effect because of the globalization of financial markets.
    The U.S. interest rate is no longer the determining force in economic
    decisions.  World financial markets are much more open now, and much
    easier for investors to participate in.
    
    	The interest rate / reserve requirement tools still work, but not
    as effectively as they once did.
    
    Don 

	Well, I've never taken one business course in my life, but I thought
the reasoning is that the rate the Feds. are raising is the rate at which
banks can borrow money.  Therefore, when this rate goes up, banks must raise
the rates at which they LEND money, so as to still make a profit on their
loans.  This rise in lending rates means fewer and fewer people will borrow
money (supposedly), and will thus have less money to spend.  When people have
less money to spend, the price of goods must go down, so that people can still
afford to buy things that they need.  This (theoretically) results in a smaller
amount of cash circulating, and thus the value of each dollar should rise. 
This rise in the dollar is what curbs the inflation, I believe.
	What happens when interest rates are low is that people have more money,
and with this increase of money, they will (theoretically) increase their
spending, which will allow suppliers to increase their prices so as to take
advantage of the consumers "new-found" wealth.  This increase in prices is the
start of inflation, as in theory, businesses will then have to pay employees
more so that they can still afford to buy what they could the previous year;
and with the increase in salaries, the price of goods must rise to make up
for the extra outlay by the companies - it is all a vicious circle.  This
is what I thought that inflation meant and why interest rates were raised to
counteract it.

Rob

    
    	-2
    
    	You are both kind of right, and both kind of a little off base.
    
    	First, Federal Reserve rates are the cost of member banks borrowing
    money from the Federal Reserve. This must be done daily by US chartered
    banks to "balance" their books. Much more effective is Fed setting
    reserve limits, but the ramifications tend to be much more dramatic,
    and is considered a draconian measure only to be used with much warning
    and tactic approval of the Treasury and Congress. (This was done in the
    late 80s following the S&L/Money Center banks debacle)
    
    	What Fed rates do in reality is send a "signal" to the markets in
    New York, Chicago, London, etc. that the US is serious about the level
    of "money" in the economic system. However, money is no longer that
    difficult to create (look at the credit card business, for example)
    and therefore increasing rates on just one segment of the money supply
    probably has very little real effect. The real effect is everyone else
    raising THEIR rates to boost their margins - and that can have a very
    dramatic impact. Which brings us back to just how much and how soon. We
    are treading new ground in the US right now. Expect the second quarter
    of 1995 to be the answer.
    	
    	Second, inflation has absolutely nothing to do with the Fed., but
    with the US Government which prints money. More money printed than is
    actually needed by the economy is what gets inflation. And gov'ts'
    print money to pay THEIR bills, not anybody elses. Since the US is
    "trying" to get its financial house in order (increasing taxes,
    decreasing spending, reducing headcount, etc.), inflation is very
    benign at this point. Wages are a primary indication of inflation
    and they are not rising faster than the "true" GNP (which most
    economists consider as minus government spending and including debt
    growth).
    
    
    			the Greyhawk

.0>    	Is the Fed operating on antiquated assumptions?  Are they like the
.0>  generals who fight the last war?
    
    There's lots of that in economic circles. It's amusing how often
    economists project the future will be like the immediate past.
    They're right when it doesn't matter and wrong when it most matters.
    
    Not only do high interest rates increase costs (inflationary), they
    also induce people to rush to borrow before the next increase in rates,
    since increases seldom come individually, and always go to extremes.
    So (in the short term) raising rates actually has the counter-effect
    of increasing the demand for loans -- not what the Fed prescribed.
    But I believe the long run turns out as expected.
    
    The huge U.S. debt and huge currency markets help keep a lid on what
    the Fed can do. Perhaps one day they will find their rate-setting to be
    irrelevant to the values set by the global market. There's no doubt in
    my mind the global capital markets know more about interest rates and
    currency values than a bunch of esteemed bankers locked in a boardroom.
    
      John

>    	Second, inflation has absolutely nothing to do with the Fed., but
>    with the US Government which prints money. More money printed than is
>    actually needed by the economy is what gets inflation. 
    
    You are way off base here. The Treasury cannot just print money and
    somehow stuff it in its bank account. And most money is electronic
    these days.
    
      John

>>    irrelevant to the values set by the global market. There's no doubt in
>>    my mind the global capital markets know more about interest rates and
>>    currency values than a bunch of esteemed bankers locked in a boardroom.


    Well, I don't necessarily know about this.  Most of the major foreign 
markets are tied to our market, so what or market does has a major impact
on the foreign markets - more so than the foreign markets have an impact
on ours.  Already banks in Hong Kong and Japan have raised their prime
lending rate to account for the rate increases here.  So, we had all better
hope that our esteemed bankers know at least as much as the rest of the world.
    Alos, if you look at some of the other 'major' economies  of the world,
you will see that they are not all that well off.  So they obviously don't
know how to do things any better.

Rob

> Already banks in Hong Kong and Japan have raised their prime
> lending rate to account for the rate increases here.
    
    Cause and effect just aren't that clear to me. There is a global demand
    for capital as Europe comes out of recession and many nations are
    growing at a high rate. Interest rate rises are natural reactions to
    this, not something crafted by clever bankers. In any country.
    
      John

    
    Fed raising interest rate itself is inflationaly.  Not to 
    mention that inflation rate is record low now.  Also a little
    inflation actually is good for the people, good for the economy.
    I believe that without a little inflation, there will be no
    significant improvement of living standard.  We have to look at
    the economy of Japan and China for example.  Their living standard
    improved a lot in the past.  Do they have inflation?  Yes.  But that
    is the price you have to pay.   Agree?
    

    
    	.5 on in -
    
    	John -
    		
    		First, I'm on base. Let me refer you to the standard
    college textbook for Econ 101, Paul Samuelson's "Economics", Chapter
    17 -The Federal Reserve and Central Bank Monetary Policy. I quote:
    
    	"The Central Bank affects money, interest, investment, and output,
    the monetary policy of a nation; on the other hand fiscal policy, the
    ability of government to control its expenditures, affects consumption,
    savings, inflation, and taxation."
    
    	It is not government printing more money and holding it. It is
    large spending deficits paid for by the government by printing more
    money. The concept of printing more money can be electronic transfers;
    but they are from the government to pay for its spending. And monetary
    policy can only soak up funds going for interest payments or for
    investment. It is fiscal policy that causes economic hardship and
    strains.
    
    			the Greyhawk
    
    
    
    

For an interesting discussion of some of these issues, see the December issue
of Harper's magazine, which contains an article about international currency
trading (written by a trader who lost his shirt--and his confidence--just
before the Gulf War).

It's written in lay terms, and I found it pretty absorbing. 

The point of the article is: Currency trading is so volatile and such a huge
industry that no one country (including the US Federal Reserve) has much
control over what's going on.

This point isn't in the article, but: Does it make sense that the Federal
Reserve isn't really fighting inflation at all in the latest interest rate
rise, but is merely trying to keep the currency strong? It seems that the Fed
doesn't have many tools anymore in keeping the US dollar sound (because of the
tremendous trade and budget deficits), but might be trying to keep the US
dollar the "currency of choice." And now with the specter of more budget
deficits (if the Republicans actually do enact their tax cuts), is the Fed
trying to keep people from fleeing the dollar?

What am I missing?

Vicki Meagher

>    	The concept of printing more money can be electronic transfers;
>    but they are from the government to pay for its spending. 
    
    Then you should say what you mean. "Spending too much money" is what
    you meant to say; which involves Congress, budget policy and all the
    attendant details. "Printing money" is an administrative function that
    doesn't need Congressional approval and in any event only affects a
    subset of M1.
    
    Though if you look at (M2-M1) year-over-year or (M3-M1) year-over-year
    the rate of change is plummeting, foreboding a sharp drop in the money
    supply. Since GDP growth is correllated with money supply growth, I
    think the real problem is deflation not inflation.
    
      John

    
    	John -
    
    	Agree with you on the M1-M3 figures, but the problem today is that
    they measure only US-held $$$. The problem we (meaning US policy
    makers) have is that nearly 1/2 of M1-M3 dollar demoninated assets are
    now held overseas. In many countries, like Cuba, Russia, Hungary, etc.,
    the "real" currency is greenbacks, but we don't count that in our
    mumbers.
    
    	The fact of the matter is economists are all wrestling with this
    "new world order" predicated on US monetary and fiscal policy that
    appears to have worldwide implications. In short the "Wealth of
    Nations" is how much dollar denominated assets they control regardless
    of the "home" of those assets. This is going to be a very interesting
    economic time over the next several years as we work through finding
    true market equilibrums.
    
    
    			the Greyhawk
    .

.10> This point isn't in the article, but: Does it make sense that the Federal
> Reserve isn't really fighting inflation at all in the latest interest rate
> rise, but is merely trying to keep the currency strong? It seems that the Fed
> doesn't have many tools anymore in keeping the US dollar sound (because of the
> tremendous trade and budget deficits), but might be trying to keep the US
> dollar the "currency of choice." And now with the specter of more budget
> deficits (if the Republicans actually do enact their tax cuts), is the Fed
> trying to keep people from fleeing the dollar?

    #1 here's one thing to think about: A weak dollar in and of itself is
    inflationary. A strong dollar fights inflation.
    
    Why? Consider what happens when the dollar weakens. The price of
    imports rises as sellers demand more dollars per {Yen, Pound, DMark}
    just to stay even with a depreciating currency. Consider that imported 
    chocolate bar (I -refuse- to use automobiles :-) which costs more due
    to a weaker dollar. Domestic chocolate makers find themselves able to
    raise prices more freely because their foreign competition is raising
    prices, too. Your dollars buy fewer goodies, that's inflation.
    
    At the same time there are various goods that become more attractive to
    export instead of sell locally. A weak U.S. currency means countries
    (say, Japan) find (say) U.S. lumber a good buy at current levels. When
    lumber leaves the country it is no longer available for sale here thus
    reducing the supply. Presuming no change in demand the reduced supply
    implies higher prices for the same item, that's inflation. (Of course
    the higher price will lower demand eventually, causing a slowdown if
    the price rises are large enough and widespread enough. But that's a
    downstream consequence of inflation, separate from inflation itself.)
    
    So a weak currency in and of itself is inflationary. No other
    ingredients (eye of Newt :-) required.
    
    #2 remember this perpetual conflict: No nation can simultaneously 
    control both the QUANTITY and PRICE of its currency. If this were
    possible, obviously every country would create huge sums of its own
    currency with titanic purchasing power, an impossible situation.
    
    If the U.S. wants a stronger dollar (higher price) then it must let
    the market dictate the money supply (quantity) appropriate to the 
    price level. A stronger dollar, meaning a higher price, thus implies
    tight money, hence higher interest rates.
    
    Conversely consider a government that wants to expand the money supply
    (i.e., encourage borrowing, usually to increase employment) or de facto
    expands the money supply via government borrowing. By targeting the
    quantity of money, willingly or no, the government gives up the ability
    to target the price of its money. Hence an expansionary monetary policy
    usually implies a falling currency, thus inflation.
    
    As Greyhawk points out, what other people think of the government is
    going to have an effect on its currency value. Currency from a government 
    that appears to be trustworthy will get more respect than currency from
    a government that doesn't show any concern for the value of the currency.
    Thus you are unlikely to find accounting identities that relate money
    supply and the value of a currency. If it weren't so sad it might be
    fun to watch Treasury pursue a "price" strategy (selling DMarks, buying
    dollars) at the same time the Fed is follwing a "quantity" strategy,
    e.g., selling bonds from its inventory. One foot on the gas pedal, one
    foot on the brake...
    
    So is the Fed supporting the currency or fighting inflation? Answer:
    both, they are intertwined. A better way of asking the question might
    be: "What indicators are the Fed relying on to guide policy?". Could
    be the currency markets, could be the price of gold, could be the M1
    money supply, could be some of each varying with the shifting winds.
    If you can come up with a good enough model you can make a fortune.
    
      John

    
    	John -
    
    	Hell, close enough, although inflation is mostly considered to be
    too much money chasing too few goods. As an old Econ prof of mine once
    said, "The best thing about Economics as a profession is that the
    contrarian viewpoint will always keep you employed."
    
    		the Greyhawk

re: .13

>    Consider what happens when the dollar weakens. The price of
>    imports rises as sellers demand more dollars per {Yen, Pound, DMark}
>    just to stay even with a depreciating currency. Consider that imported 
>    chocolate bar (I -refuse- to use automobiles :-) which costs more due
>    to a weaker dollar. Domestic chocolate makers find themselves able to
>    raise prices more freely because their foreign competition is raising
>    prices, too. Your dollars buy fewer goodies, that's inflation.

This is something that has always confused me.

Why do domestic "chocolate makers", already battered by the market's
perception of the imported goods as superior, weakened by the competition
from these foreign outfits, use this situation as an opportunity to jack
up prices to consumers who are already suspicious and angry about inflation,
thus causing further ill will between themselves and those who they depend
on for their cash flow?

Why not use this situation as an opportunity to seize market share back
from the competition by emphasizing the price advantage they now enjoy?
Since most consumers shop price above all else, this would seem to be
the proper action, yet instead the usual play is the opposite.

It just seems so short-sighted.  Sure you improve your margins this quarter,
but since you haven't increased your share of the business, how does raising
prices help?  Ultimately, competition will force margins back down again.

>Why do domestic "chocolate makers", already battered by the market's
>perception of the imported goods as superior, weakened by the competition
>from these foreign outfits, use this situation as an opportunity to jack
>up prices to consumers who are already suspicious and angry about inflation,

Because they really want to be domestic auto makers?

>   Why do domestic "chocolate makers", already battered by the market's
>   perception of the imported goods as superior, weakened by the
>   competition from these foreign outfits, use this situation as an
>   opportunity to jack up prices to consumers who are already
>   suspicious and angry about inflation, thus causing further ill will
>   between themselves and those who they depend on for their cash flow?
>
>   Why not use this situation as an opportunity to seize market share
>   back from the competition by emphasizing the price advantage they
>   now enjoy? Since most consumers shop price above all else, this
>   would seem to be the proper action, yet instead the usual play is
>   the opposite.
IMHO it is because they are short term oriented.  Their idea of long
term (or very long term) planning is for next year.  In the short term,
their earnings will increase.  This will look good on their quarterly
report.  Analysts will notice and advise their clients to buy the stock. 
The price of the stock will go up.  Many company executives are rewarded
when the stock goes up since they have stock options and bonuses based
upon short term performance.

>   It just seems so short-sighted.  Sure you improve your margins this
>   quarter, but since you haven't increased your share of the business,
>   how does raising prices help?  Ultimately, competition will force
>   margins back down again.
The reward system needs to be changed if you want to see long term
strategies.  The governments tax policy with long term capital gains
doesn't help either.  Not to mention the policy of penalizing savers.

While I agree with the previous noters (re: rewards for short-term
performance, etc.), could it be....

..that cocoa prices have been rising and all producers are passing
through the increase?

..that demand for chocolate is not that elastic and that consumers 
will not change to a different taste in chocolate, despite the lower
price, in significant enough numbers to make sacrificing the additional
revenue economical?

    Not to defend those greedy domestic chocolate makers (heck almost ANY
    imported chocolate is better than U.S. domestic, Yugoslavian excepted)
    but look at the differences:
    
    Raising prices is real easy. There are tons of accounting details but
    basically you already have the [chocolate] bean-counters on hand to
    take care of that. Profits are guaranteed, or as close to that as
    possible. Risks are low.
    
    Going for market share is fraught with difficulty. You may have to
    invest in factory purchase or modernization, that takes capital.
    You have to hire new workers and with the ever-increasing mandates
    from the government you never quite know what you're getting into.
    Suppliers may not be able to meet your increased demands for much
    the same reason. If you are successful, in a few years, who knows what
    your taxes and new obligations will be? The risks are quite high.
    
    Under the circumstances I find it difficult to argue against 
    raising prices. How can we expect industry to take a long-term view 
    when the laws change yearly?
    
      John

>   How can we expect industry to take a long-term view when the
>   laws change yearly?
It's all the voters' fault.  8-)

They keep changing the politicians in office.  The new politicians
feel that the voters want them to change things so they change the
laws.  They also feel obligated to make laws that help the people
that put them in office (in particular those that contributed
heavily to their campaign, not necessarily those that voted for
them).

The laws don't necessarily get better, just different.

I agree that it is difficult to make long term plans with so many
moving targets.  I don't think that they should give up trying
though.

Thanks for the risk comparison, John.  That certainly explains part of
the motivation for simply raising prices (it's the lower risk tactic), 
but I'm still nagged by the missed opportunity to grow the business.  

Why would one pass up the *opportunity* to grow one's business and
ultimately return more to the shareholders, when the only risks one
has to face are risks that would have to be faced anyway if it was a
growing business in the first place?

    Matt,
    	In reading your original reply I found the answer to your
    question.  The statement was that "most people price shop" and
    the question was" why wouldn't the domestic chocolate makers use
    this opportunity to increase market share".  The answer is because
    most people price shop, you wouldn't gain any sustained market share.
    As soon as the imported chocolate prices returned to normal, the price
    shoppers would go right back to their normal brands and no market
    share was gained by anyone.
    
    Market share in commodity markets is principally driven by price. The
    instant prices go up, market share usually goes down.
    
    

Re: .19, 

>     Raising prices is real easy. There are tons of accounting details but
>     basically you already have the [chocolate] bean-counters on hand to
>     take care of that. Profits are guaranteed, or as close to that as
>     possible. Risks are low.

	For many industries, including ours, price decreases are the
	normal. Just look at disk prices, memory prices, chip prices, 
	etc.  Strategically, I would plan for price decreases and
	strive to reduce my mfg costs accordingly.

	As others have pointed out, competition is one big factor
	that will make price increases very difficult.

	For other products, price is but one factor in the purchasing
	decision.

Gim

	I finally read recently (I forget where) a coherent explanation of 
why the Fed is pushing up interest rates.  As I suspected, it doesn't 
really have that much to do with inflation--that's a smoke screen.  The 
Fed's continuous problem is to keep U.S. government securities attractive 
enough on the world market; about a third of these securities are sold 
outside the U.S.  As several responses have touched on, the weak dollar 
makes foreign investors edgy enough, so they need higher interest rates to 
keep them coming.  The conclusion of the article was that high interest 
rates are a kind of delayed tax we are paying for gigantic run-up of the 
U.S. public debt.  (I will stifle my political views; everybody has their 
opinion about who's responsible. :-)

		David

> 						As I suspected, it doesn't 
> really have that much to do with inflation--that's a smoke screen.  The 
    
    I think this may be somewhat of an overstatement. The Fed was created
    in 1913. The U.S. didn't do much international borrowing until 1975 or
    1982, depending on your definition of "much". Are you implying the Fed
    spent 60+ years in a smoke-filled international vacuum?   :-)
    
    It is possibly interesting to consider what life would be like without
    the Fed. Would finance cease to exist? Doubtful. If there were no Fed
    would the U.S. still be issuing bonds? Certainly. Internationally? Yes.
    
    Suppose you're a foreigner (foreign to U.S. :-) and you own a passel of
    U.S. Bonds and there were no Fed. You have two concerns:
    
    [1] U.S. Interest rates will rise, causing the face value of your bonds
        to decline. You see this as bad.
    
    [2] The U.S. dollar could fall, causing both the face value and interest
        payments to decline in your currency. You see this as bad.
    
    Of course the opposites can happen too, and you'd make money. Or, as is
    more often the case, one of the above happens and the other doesn't.
    In 1993 we had generally falling rates and generally falling dollar,
    so the overall goodness of this would depend on relative quantites.
    
    Back to our fantasy. As a bondholder, what do you do when rates rise
    and the dollar falls? Some owners will sell their bonds, much like one
    might sell a falling stock. That has the effect of driving up interest
    rates (by lowering bond prices). This is a market mechanism --
    adjusting prices to meet demand. No Fed, but the market still works.
    Even without the Fed, the markets will keep U.S. government securities
    attractive. Just as markets keep everything priced correctly.
    
    So what good is the Fed? I'm not sure it's ANY good but the standard
    argument goes that the Fed fights inflation by raising interest rates
    (by selling bonds from its inventory) when it smells inflation in the
    distant future. And the Fed fights recession by lowering interest rates
    (by buying bonds for inventory) to encourage borrowing, thus economic
    expansion. AND the Fed fights a low dollar by buying dollars (selling
    other currencies from its inventory) and it fights a high dollar by
    selling dollars (buying currencies for its inventory).
    
    But these levers are not independent of one another. Obviously the Fed
    can't fight both inflation (by selling bonds) and recession (by buying
    bonds) at the same time. And tweaking interest rates will have currency
    impacts: raising rates will make U.S. bonds more attractive to new
    buyers, thus raising the dollar's value. Unless (as is the case today)
    investors fear yet more rate increases in the future. Some bond buyers
    will hold off buying today on the theory that prices will be lower
    tomorrow. Lots of money will be made by those who correctly decide when
    this round of increases is over. It's just like buying DEC at 19.
    
    So why does the Fed do what it does? I think it's more a matter of what
    is the key monetary problem of the moment: inflation, recession, the
    value of the dollar. The Fed has to decide which of these is the most
    important, and make policy appropriate to resolving that problem.
    
    It is fair to say the low value of the dollar is probably more extreme
    than the threat of inflation or recession, and the Fed should be most
    concerned with that problem. Reality, however, remains sealed in the
    unpublished minutes of the most recent board meeting.
    
    RECESSION ALERT: For the first time in 4 years (just before the 1990
    recession) the yield curve is inverted. The 5-year note is now yielding
    a touch more than the 10-year note. My bet is that in another 8 months
    economists will identify this month as the official start of the next
    (current?) recession.
    
      John

.25>    I think this may be somewhat of an overstatement. The Fed was 
.25> created in 1913. The U.S. didn't do much international borrowing until
.25> 1975 or 1982, depending on your definition of "much". Are you implying
.25> the Fed spent 60+ years in a smoke-filled international vacuum?   :-)

	My statement was in the present tense.  The Fed does (and has 
done) a lot of different things over the years, and currently they're using 
inflation as a convenient cover for the real reason(s) they are jacking up 
interest rates.  As you point out, interest rates may have jacked 
themselves up anyway.

		David