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April 12, 2006
Mr. Greenspan And The IMF Find Common Ground?
Greenspan warns on global asset price fall, Financial Times/Reuters: Former Federal Reserve Chairman Alan Greenspan warned on Wednesday a global glut in liquidity would result in a fall in asset prices.
... while Kash has this at Angry Bear:
WASHINGTON (MarketWatch) -- After several years of low interest rates and ample liquidity, storm clouds are developing over global financial markets, according to a new report from the International Monetary Fund.
Well, by definition higher interest rates mean lower bond prices, and I guess the idea is that, because an equity price is something like the discounted flow of future dividends, higher interest rates mean lower equity prices too.
Is this bad? Before you answer that question, the first thing to recognize is that interest rates are prices, and prices don't just magically change -- they rise or fall because demand and/or supply change. If interest rates are rising because global economic growth is strengthening and investment opportunities expanding, I'll have to put that in the good, or at least benign, category. (And note that higher interest rates do not mean that equity prices fall -- while higher interest rates mean a larger discount is applied to dividend or earnings flows, it is also the case that faster growth means those flows themselves increase.)
On the other hand, interest rates may rise, particularly in the United States, because global savers lose confidence in the dollar, or financial fragilities cause global production opportunities to contract. I'll put those types of rate increases in the bad, or at least not-so-good, category.
If I had to guess, I would put Mr. Greenspan closer to the good-to-benign story. From the (UK) Times Online:
Mr Greenspan said that the situation would end when the amount of excess capital dropped. “I don’t know when the liquidity is going to decline, but I am reasonably confident that what we have is an abnormal situation,” he said. His comments echoed his famous 1996 warning over “irrational exuberance” in markets. However, asked yesterday whether the same diagnosis applied to present conditions, he said: “I would hesitate to use it in today’s context. Irrational exuberance, I think, would be a stretch at this point.”
Comparing that savings-gluttish take with the "storm clouds" rhetoric of the IMF, I'm not quite sure Mr. G and the good folks at the IMF see quite the same picture just yet.
UPDATE: Kash suggests, in the here and now (as the 10-year Treasury yield finally breaches the 5 percent threshold), the "rise in rates reflects a belief that the economy will continue to remain strong through the rest of the year."
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