Drowning in cheap money (Jim Jubak)

Created by : Francis Goodwin View profile

If there is a major stock market tumble, it won't be the fault of the overall U.S. economy. Instead, point the finger at too much risk-taking in the debt market.

By Jim Jubak -- MSN Money

March 6, 2007 -- After Federal Reserve Chairman Ben Bernanke's Feb. 28 testimony, one member of the House Budget Committee asked him whether the sell-off in global stock markets a day earlier -- and in particular the 416-point drop in the Dow Jones Industrial Average -- had changed the Fed's thinking.

"There is really no material change in our expectations for the U.S. economy since I last reported to Congress a couple weeks ago," Bernanke responded. "If the housing sector begins to stabilize, and if some of the inventory corrections that are still going on in manufacturing begin to be completed, there is a reasonable possibility of strengthening of the economy sometime during the middle of the year."

Absolutely true, as far as it goes. But it doesn't go very far. Yes, nothing that happened on Feb. 27 changes the U.S. or global economic picture. But this time it's not the economy, stupid.

The pyramid could crumble

What's more important is what Bernanke didn't say: that this time, the biggest potential danger isn't from a slowdown in the U.S. or Chinese economies. It's from the pyramid of leverage in the debt markets created by traders and speculators using cheap money from around the globe, and in particular from Japan. The sell-off of Feb. 27 demonstrated how a panicked unwinding of that pyramid of debt could send financial markets into chaos.

His answer on Feb. 28 was reassuring to the markets in the short term, but I worry that all it does is extend the complacency about risk piled on risk in the debt markets that got us into this fix in the first place.