Saturday, September 22, 2012

Heads: you lose. Tails: you lose.

Referring to my previous posts, I'd say there are two things we can take as a fact:

  1. Norges Bank imports low interest rates from rest of the world (as I mentioned here), where the current growth dynamics are a lot less favourable than in Norway.
  2. These low interest rates have "greased" the wheels of the Norwegian economy, leading to house prices increasing faster than income and, partly through the wealth effect from rising house prices, to increased consumption (cars, trips abroad, luxury items).
Now, if we look at the level of interest rates and think of three possible future scenarios for Norway: a) Norges Bank keeps on importing low rates for some years to come (as it is a fair assumption that rates will be kept low by Fed and ECB). By this Norges Bank would continue greasing the wheels of the Norwegian economy and risk a massive bubble (if we don't have it already). The probable outcome of this would be more negative than positive. And if you consider the reason for low rates elsewhere, which is very low growth and even depression-like environment in many parts of the developed world, you understand that Norway will not be insulated from a downturn forever.

So I'd say this is not the right time to be inflating a bubble. By inflating a debt bubble Norway is getting into a trap: either the interest rates remain low, which means the world economy is in serious trouble, and that will start affecting the Norwegian economy sooner or later, or, b) the world economy improves, interest rates start to rise and the rising share of interest payments of total income will be a big drag on Norwegian economy for years to come. It is of course not much different from the debt trap the whole developed world finds itself in now, and to me it just seems that Norway doesn't realise that it is in the same debt trap already, caused by too low interest rates for too long, pushing us to borrow more and more growth from the future. For too long it has been a lot easier to spend money you don't have than spend money you have.

There is of course a third scenario, and this is the only scenario where Norges Bank would really act and use the power it has, instead of feeling powerless and hoping for the world economy to pick up. I would even suggest that this is the road that Norges Bank should take to avoid a big crash in the likely circumstances that the world economy is going to slow down even more in the years to come. What I'm talking about is, c) Norges Bank increasing the policy rate (let's say by 0,25 %-points quarterly, for the next 3-4 quarters), letting the Krone appreciate in the short-term and cool down the clearly overheated economy. I'm not sure if this would be enough, but I think we are quite close to some "tipping point" in the housing market anyway, so sending the message that the "housing party" is not getting better anymore could be powerful.

I know the last option is in practise hard to accomplish and thus unlikely, because no one wants to be the one who takes the "punch bowl" away and by this risks an economic downturn, even if it would be inevitable soon anyway. I just want to remind that the former Fed governor, Alan Greenspan, did not take the punch bowl away early enough either and we all know what were the consequences of that inaction. It is time to face the facts and start limiting the near-inevitable hit the Norwegian economy is going to take due to the current excesses. I would guess this is something that keeps the prime minister, Jens Stoltenberg, awake at night.

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