Subprime Mess
There just doesn’t seem to be an end to this subprime mess. I remember a year ago and hardly anyone really knew what it was and what it could do. Nobody saw it as a threat. Nowadays, the thought of subprime make investors head for cover. Like a disease it has spread out and/or it has affected companies not just in the US but also in a global scale (in some way shape or form).
The US Federal Reserve chairman have been battling these credit issues by cutting interest rates. At the same token, it is increasing inflation. So, in order to combat inflation they need to raise their interest rates. Now this is where inflation and rates makes it a double edged sword. The Federal Reserve has to make a decision whether:
- Do they want to fight inflation?
In order to do that, you have to increase the interest rates. If you increase the interest rates, this will put a lot more of home owners, property speculators and (overstretched) investors into foreclosure - driving the economy to a much slower growth >> which decreases demand for goods and services >> and eventually will increase unemployment and increase the cost of living. In the short run, it may not be good for the economy. Not good at all.
However, in the long run - increasing the cost of living would decrease the spending on luxury goods and therefore, would increase the chances for household(s) to save - and save for their future. In the long run, the economy will eventually come back to equilibrium.
- On the other hand, does the Federal Reserve want to keep interest rates low?
By keeping the interest rates low, it is saving some homeowners who were lent money and overstretched themselves on their mortgages. However, keeping interest rates low will just speed up the process of inflation. As some people may find that goods and services are cheap - they end up spending more. As they buy more, it increases demand on goods and services and at the same time it decreases the supply. Hence, prices rise and creates inflation.
Additionally, lowering interest rates drives the value of the US dollar down. Capital and investment tends to flow towards countries with higher yielding currencies. As US exports get cheaper the imports gets expensive for America. This creates a flow on effect on other countries. As imports value increases, it creates a slowdown in demand for imports and slows down production (in exporting countries) for goods and services. Considerably, US is the number one consumer in the world and this will have a huge (if not - it’s already happening) effect on other countries.
There are a whole lot of other things that makes this whole subprime issue a big mess. Lately, the Fed Chairman Ben Bernanke has hinted at another rate cut this month. Let’s see what happens. This will be some interesting times.
I hope this gives you some light on economics. Until then, stay tuned for more posts on subprime… Enjoy your day! 
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