The Interest Rate Blues

Wow! I just couldn't believe it. I knew it was bad; but gee whiz! The Commerce Department has come out with the new numbers concerning new housing starts in 2007. The sharp decline (26.4 percent) shattered the old mark of 23.1 percent set in 1980 when prime interest rates were over 3 times of what they are today. These numbers tell a story which is very disconcerting to say the least. There are economists who are painting a doom and gloom picture while other economists are still ignoring the alarm bells. The reality of the situation is probably somewhere in the middle; however, lets apply some basic economic principles to the problem and analyze the numbers more closely.
We have to ask ourselves a not so simple question in order to understand how interest rates can be at close to record lows while housing starts are at an all time low as well. Common sense would seem to tell us that housing starts should be booming if interest rates are at or near the bottom. The variable that needs to be analyzed closely (because it is truly the wild card) is consumer confidence. Consumer confidence has been plummeting since early 2007. People are becoming very scared when thoughts are being considered concerning new home purchases. Most people are scaling down plans and purchasing used homes. Another alternative is to forego the purchase altogether. The latter is becoming the all too frequent solution to a dismal outlook of their future.
This overall problem of poor consumer confidence can bring an economy to its knees. The same dilemma faced the depression era populace and caused a second wave of economic anxiety when millions of Americans made a huge "run on the banks" in 1937. The government had to temporarily close the banks to give the public time to cool off and to reconsider their actions. I don't believe that the current crisis is anywhere near this crucial at this point; however, it is noteworthy to remember the role consumer confidence plays in the determination of how our economy expands or contracts.
The above paragraph can be contrasted with a period during the early 1980's when Fed Chairman Paul Volker raised prime interest rates above 15 percent in order to decrease inflation. The difference between today and the 1980's can be traced to The Great Communicator. President Reagan was able to slowly restore faith in the economy; and it was greatly accelerated during the greatest economic boom of the century in the ensuing decade. Many economists today believe we need to continue to raise rates despite the low consumer confidence levels. I think the difference maker will be the quality of leadership that emerges after the 2008 elections. Our economy will depend more on that factor than any economic index in 2009.
The one thing that we can depend on in the near future is uncertainty. This will make business working capital difficult to obtain. Business consolidation of debt may prove to be pivotal to survival and business expansion might have to take a back seat until we determine what the outcome will be. This makes this election year more important than any other since The Great Depression.
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