“MAPping The Future” Column in the INQUIRER – 14 January 2008
"Fed Cuts Rate a Quarter Point – Part 2"
by Aurelio O. Angeles
Let me now get back to the long chain of returns and earning assets that must be
evaluated with care for its viability and soundness.
This very long chain of returns and earning assets is what is called the national
What has all this got to do with the Fed's recent rate reduction?
Interest is just one item of cost
No matter how low the interest rate that the Fed Reserves sets for the economy, and it
may even reduce it to zero, such lowering of interest rate will not necessarily produce
First, what will it surely do? Because the lower cost of money, a rate reduction will
surely encourage people to borrow. But if they do not generate enough income, they
won't be able to repay the loan. Result? Bursting bubbles.
And a rate reduction may also set wildfires in the financial markets where wizards make
money on money - that's money making money on paper basically.
Will the lowering of interest rates result in increased and sustainable aggregate demand
Well, let me tell you that I am a businessman and interest is just a small component of
my total costs and total income. I won't invest in additional equipment and plant to my
business just because the bank lowered its rates on my loans.
Let me also tell you that I have many friends whose problems are access to credit, not
really the cost of credit, and they are wondering where in the economy is all that touted
cheap money going to.
If the aim of reducing interest rate is to release cheap money to crank up the engines of
economic growth, it would be an act of Sisyphus, the Greek mythology king who was
cursed in all eternity to roll a huge boulder up a hill only for it to roll down again.
Interest rate is not a kind of snake oil that cures all diseases. Central banks are wrong for
treating it so.
Economic growth comes from serving customers
Economic growth comes from serving people with real goods and services with
values that are competitive in price, not just quality, in the world market. Now that's
Three decades or more ago, before globalization set in, an economy with abundant
natural resources could grow from its internal factors of production (labor, capital
and land) unmindful of incursions of outside markets.
This situation brought about INWARD-looking economies and the advantages of
being INWARD-looking as an economy. "We have got to be strong on our own!"
was a frequent slogan.
In layman terminologies, if you were an American businessman, your customers
would be mostly Americans. If you were an American consumer, you purchased mostly
Thus, the US government would not establish export promotion as a do-or-die
economic policy. This made sense because Americans were prosperous simply by
dealing with fellow Americans in their own land and seas.
Under such a scenario, GDP was the only measure of economic performance and
interest rates and the reduction of inflation rate were almost always the key strategy
for maintaining real growth. And under that condition, the performance of the U.S.
financial markets would effectively reflect the strength of the U.S. economy.
No reference would be made on the role of the exchange rate as a key policy for
economic growth, after all the FX rate is used for international trade.
This in fact happened to the USA, a highly inward-looking economy.
Not so with Asian countries such as Japan, Korea, Taiwan. These guys knew as
early as the end of the Second World War that their true customers were NOT
themselves but the rest of the world.
Then, in the early 80s China followed the same common-sense thinking with the
entry of Deng Xiao Ping.
Who is the customer in the global economy?
It is easy to see their logic. Would you consider your sales to your brothers and
sisters in the same household a great sales achievement? Or, in the terminology
of economics, an engine of economic growth?
Globalization later debunked the validity of INWARD-looking policies of the USA
and showed the wisdom of the economic policy framers of Japan, Korea, Taiwan,
and now China.
Before the onset of globalization, it was alright for US economists to measure
economic performance principally with one yardstick - GROSS DOMESTIC
PRODUCT. And it might have been alright then to consider just interest rate
adjustments and control of inflation rate as the principal policy instrument.
In the age of the global economy, however, these are not enough, for the customers
of a country are not its citizens, but the rest of the world.
Current Account Balance, the real measure of performance
The real measure of performance is now CURRENT ACCOUNT BALANCE,
the difference between inflow of dollar earnings of an economy and the outflow of
its dollar expenditures in a given period in its business with the rest of the world.
Briefly, the major components of the current account balance are net trade balance
(exports of good and services less imports of goods and services) and net factor
income (inward remittances of labor income and investment income of US citizens
abroad less outward remittances of foreigners of their income earned in the the USA).
Note: except for some factor income, these international business transactions have to
do with the production and marketing of real goods and services.
In practical terms, the current account balance measures the earning capacity in US
dollars of an economy with respect to the rest of the world and it also shows the
economy's lack of earning capacity or competitive advantage with respect to the
Do you see why?
If the balance is consistently positive, meaning consistently in surplus, then it has
competitive advantage with the rest of the world. If the balance is consistently
negative, meaning always in deficit, then the economy lacks competitive advantage
with respect to the world.
I would like to ask you a question: how does the Current Account Balance of the
USA stand for the past twenty years - from 1987 to 2006?
The answer: For this entire period, the USA earned a surplus only in one year, 1991,
a measly US$2.9 billion, and its accumulated current account deficits for the period
amounted to a negative $5,735.7 billion.
So, we ask: what is the best measure of economic performance?
GDP? In olden times, that answer could have earned an A+. Now, in the global
economy, it is Current Account Balance, not just GDP.
No wonder, we see bubbles bursting in the USA even if it has the largest GDP in the
And, if the stock market indexes or indexes related to financial instruments now show
erratic movements, it is because they have no solid and positive Current Account
Balance to stand on and the cracks are beginning to show.
Cash-rich individuals and nations would consider that indeed these indexes the major
and, perhaps to some, the only measure of economic performance. Well, that may
be because they have so much savings in their hands but with so little vision in their
hearts in what productive undertakings they can place their savings.
The real underlying earning assets in the economy
In the end, the underlying earning asset of the US economy is not the performance
of its financial markets.
The underlying asset is still its working, creative people, the level of production of
goods and services and the competitive value of their exports to the people of the
rest of the world.
The devaluation of the US dollar which makes these exports competitive in the world
market is in the right direction, although it may provide initial pain especially to players
in the financial markets.
And two years from should be long enough for the restructuring of the U.S. economy
to make domestic production competitive against imports, for exports to increase at a
faster rate than imports, for employment, income and savings to increase and for the
economy to experience reversals in the trend of negative CURRENT ACCOUNT
And, truly,two years are short enough for markets to rebound backed up by "strong
fundamentals" - the improvements in the REAL economy.
(The article reflects the personal opinion of the author and does not reflect the official stand of the Management
Association of the Philippines. Rey Angeles is the author of the books, The Peso Exchange Rate: Why Are We So Poor?
and the newly released The Philippine Economy: Do Our Leaders Have A Clue? Feedback at
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