July 2, 2004

Fed Raises Fed Funds Target and Discount Rate by 0.25%...to the surprise of no one.

Fed watching these days is almost getting boring.  When the Fed does raise interest rates, as it did earlier this week, all of the talk is about how it was expected and what will they do in the next meeting.  All we can do is sit around and wait for the August meeting.  Being bored is wonderful.

Gone are the days when the Fed had to react (or over react) to rapid changes in the economy.  Instead today the Fed is much more forward looking and much more transparent about its goals and intent.  So where is monetary policy heading?  Probably no where fast any time soon.

The recovery seems to be doing well, all things considered.  The recent run up in inflation is due to temporary factors like food and energy prices.  (Having said that it is always good advice to watch for inflationary pressures as the economy picks up steam.)  However, the monetary aggregates seem to suggest rapid inflation is unlikely any time soon in the U.S.

All the same watch the Fed to continue to raise interest rates, very slowly, for the rest of the year and probably into 2005.  The Fed wants the economy to grow, create jobs, and increase wages…but not too fast.  The Fed is also interested in not “rocking the boat” so watch for them to talk a great deal about raising rates before they actually do it. 

As the Fed attempts to slowly tap the breaks on the economy most economists expect a healthy annualized growth rate in the low to mid 4% range for the rest of the year.  That is a very healthy growth rate for the U.S. economy.

All of this, of course, assumes no outside negative “shocks” to the economy. 

Europeans doing the “U.S. flip.”

The European economy needs growth companies.  High tech firms are needed to increase European productivity to keep European labor competitive. Europe also needs fast growing firms for job creation to help reduce the high European unemployment rates.  But Europe has a problem:  there has been an increasing trend of fast growing European companies flipping their location of incorporation to the United States.

For many years mature companies, both American and foreign, have switched their incorporation and registration to Delaware, most often for tax purposes.  But recently many young, fast growing European firms are going through the quick and simple process of setting up a holding company in Delaware.

Some might suggest that this is really not that big of a deal, since these young European firms continue to operate mostly in Europe.  That is a powerful argument.  On the other hand, one wonders why are these European firms doing this U.S. flip?  The answer is:  financial market access.

Many of these young European firms have become frustrated with the lack of financing options and the poor IPO market in Europe.  Thus, they are registering as Delaware based firms in order to make it easier for them to access the U.S. venture capital markets and ultimately for an IPO in the U.S. equity markets.

What to make of this?  It certainly makes it easier for U.S. investors to invest in European firms, and it increases the financing options available to these young European firms.  The losers in this will be older European firms reluctant to do a U.S. flip and European financial market makers.  Will the European financial markets and policymakers read the handwriting on the wall?  Will they undertake some of the structural reforms that Europe needs?  Or will more and more young European firms really be quasi-American firms?  

China, the EU, and American Bankers

The Chinese government has put a great deal of pressure on the EU to recognize the Chinese economy as a “market economy” for the purposes of international trade.  After a long analysis Brussels has issued a long list of reasons as why the Chinese economy is not, in fact, a “market economy.”

American investors in China should take note of what Brussels is saying.  The EU has pointed out that there is still far too much state interference in the Chinese economy, China has weak to no rule of law, corporate governance is extremely poor and its financial markets are extremely inefficient…to put it nicely.

Despite the warnings coming from inside and outside of China about that status and structure of the Chinese economy American banks are forming consortiums that are gobbling up Chinese bank non-performing loans.  So…the Chinese banks can not seem to get these state owned enterprises to repay their loans, but for some reason, American banks think they can.  Can you say:  irrational exuberance?

To all of you in the States, have a Happy (and safe) Independence Day!

All the best,

MB