(Extra) March Rate Cut

March has been troublesome month in an unstable time. Several negative economic indicators, the fall of Bear Stern, and 74% American believe the nation is now in recession. Many have expected at least a 75 basis points cut from the Federal Reserve to boost the economy. Nonetheless, the previous Uncle Sam $200billion package only stimulates the market for a day. So what can 75 basis points really do?

The internal dispute news from the Fed leads me to guess the possibility of the two contrary options in today’s meetings: 1) catching the knife with their bare hands, 2) letting go of the falling knife. For option one a huge rate cut is a must, but for option two the Fed may only cut 50 basis points or less. It will be interesting if the Fed take a bolder move and increase rate. Of course the former option is much more possible than the latter. Either way the Fed is trying to catch falling knives. However, a huge rate cut leaves less wiggle room for the Fed and creates more inflation which might lead US towards the same track of Japan in the early 90s.

The $110 barrel of oil

This week a barrel of crude oil (hereafter I’ll use oil instead of crude oil) has reached $110 where it was only $60 a year ago. Many claimed (and hoped) $100+ barrel is temporary and soon enough it will fall back to the good old days. Being a buzz-kill I have to disagree. Even though we have self-claimed oil producers, but most of them are oil extractors. We can only produce oil with high pressure or bacteria, but currently these methods will use more energy than it produces. Hence the phrase oil is a non-renewable energy.

By using simple human logic, if something gets rare it will become more valuable (or expensive). So why should oil price remain constant? It shouldn’t. The other question will be what drives the price to almost double in 07, instead of a steady rate of increase which never actually happen to America?

Texas Senator Ron Paul, an Austrian Economist, explains it is all because of the weak dollar. The Dollar has devalued 30% based on gold, causes goods and services 30% more expensive.

Then what caused the other 70%? The rest is more of a Keynesian demand-pull inflation. Our fellow average Joe and Jane have used more oil to fill their tanks and heat their houses. Wars have been using lots of oil. Also, China and India has consumed more oil to produce more products and fill their gas tank. Hence, about 2 years ago Time Magazine made a satire cartoon where you saved $2 on a pair of sneakers made in China and spent it back on the gas pump.

Next: A few suggestions to slow down the oil price increase

Buying a House now?

This week when I was reading CNN headlines, one particular one shocked me. According to CNN now is the best time to buy houses (in 4 years). Most people do believe “buying property is always better than renting”, because renting is just throwing your money away and help the owner pay his mortgage. Buying a house is also a good investment and you can get foreclosed houses at a bargain price.

Well, the statement is true to some extend. However, there are a couple points new home owner tend to ignored. And I personally doubt this is the rock bottom of the "sub-prime mortgage".

1. Interest adds up even at 6%:

$100 compounded at 6% for 30years equals $574. So taking a huge long term loan you will be paying interest half of the time.

2. Try to save up 20% down.

0%, 5% or 10% down will only make you pay more interest.

3. You don’t need a 5 bedroom house with front & back garden and a swimming pool.

Again, huge long term loan is a no brainier. Be realistic with what you need and know what you can afford.

4. Can you pay your mortgage for half a year with your emergency fund?

In uncertainty times like theses, companies will layoff staffs to cut cost. Also, it will be tough to find a job, or sell your house.

5. Foreclosed houses tend to need heavy maintenance.

Think about it. You’re fire, can’t pay your mortgage, bank foreclosed your house. You might break a wall or two, or at least trash your house before you leave.

Inflation and tax

On the other day, I was having one of those small talk moments with my landlord. He complained that he should have a tax break because he has no kids. It should not be his responsibility to fund the local school system through his tax dollars. And somehow, his extra dollars saved in tax can help lower the inflation.

As interesting as his claims sound, nothing will change in the big picture. Giving tax breaks to taxpayers with no child is as same as taking $5 from your left pocket (government spending) and putting it in your right one (consumption and investment). Overall nothing did change in GDP.
GDP = Consumption + Investment + Government Spending + (Exports – Imports), or
GDP = C + I + G + (X-M)

If you assume the government spending remains the same then my landlord is also wrong. There's an increase in GDP, hence inflation and increase in money supply.
velocity * money supply=real GDP * GDP deflator
velocity: stays stable in the long run

However, his tax dollars did not went to waste up to some extend. Better funded schools tend to be better schools, therefore increases the housing prices in that district.

ps. I will leave the US school system for a further discussion.