There’s No Crowding Out Here.

People who worry the most about the recent increases in US government borrowing are generally worried about one of two things: crowding out or inflation.  They fear that either if The Fed doesn’t “print new money” for the govt to borrow, then the government’s demands for borrowing money will drive up interest rates.  This driving up of interest rates would then, in turn, discourage businesses from borrowing/expanding/growing.  I’ll deal with the inflation fear in a different post.  But right now, it appears there’s little prospect of crowding out.  It’s true businesses (and households) aren’t borrowing, but it’s not because of high interest rates.

In the past, when the government became a heavy borrower, there was talk about crowding out private borrowers. But this time, interest rates have remained low and no one seems to be worried about that.

The reason is simple: Rather than crowding out the private sector, Uncle Sam is now standing in for it. Much of the government borrowing went to investments in financial institutions needed to keep them alive. Other hundreds of billions went to a variety of programs aimed at stimulating the private economy, including programs that effectively had the government pick up part of the cost for some home buyers and some auto buyers.

via Off the Charts – A Rich Uncle Picks Up the Borrowing Slack – NYTimes.com.

TheSpec.com – BreakingNews – New bubble created by U.S. policy

Steven Pearlstein of the The Washington Post explains via this story in the Hamilton Spectator why the run-up in the stock exchange of the last 6 months isn’ t necessarily a good thing.  Instead of being a predictor of good times to come, the run-up in the stock market is more likely the latest in a series of financial bubbles.  We started with real estate & S&L’s in the 80’s, then it was dot-com’s and tech stocks in the nineties, then back to real estate and houses until 2006, then oil and commodities in 2007-8 (remember $130 barrel oil?).  We still aren’t reforming our financial system and we’re still letting speculators, bubble-blowers, and Wall St drive our policies.

Less encouraging is what’s happening on Wall Street. It turns out that all those bold and necessary steps by the Federal Reserve to prevent the financial system from collapsing wound up creating so much liquidity that it has now spawned another financial bubble.

Let’s start with the $1.45 trillion that the Fed has committed to propping up the mortgage market – money that, for the most part, was simply printed. Effectively, most of that has been used to buy up bonds issued by Fannie Mae and Freddie Mac from investors, who turned around and used the proceeds to buy “safer” U.S. Treasury bonds. At the same time, the Fed used an additional $300 billion to buy Treasurys directly. With all that money pouring into the market, you begin to understand why Treasury prices have risen, and interest rates have fallen, even at a time when the government is borrowing record amounts of new money.

At the same time it was printing all that money, the Fed was also lowering the interest rate at which banks borrow from the Fed and each other, to pretty close to zero. What didn’t change was the interest rate banks charged for everyone else. As a result, “spreads” between what banks pay for money and what they charge are near record highs.So who is doing the borrowing? By and large, it’s not households and businesses, which are reluctant to borrow during a recession. Rather, it’s hedge funds and other investors, who have been using the money to buy stocks, corporate bonds and commodities, driving prices to levels unsupported by the business and economic fundamentals.

I recommend reading the full story at the link.