Wednesday, October 31, 2007

Waiting for the Fed, still obsessing about the $

In two hours we will know the Fed's latest move. Another interest rate cut is generally expected. If it happens there will likely be a reinforcing action by the markets, with the U.S. equity market inching up on the hope for more liquidity for the troubled areas in the securities markets and the foreign markets up on currency valuation. The underpinnings of what value the dollar has will continue to be undermined. Is the short term benefit of an interest rate reduction worth the long term danger of a weakening currency.

An interest rate reduction will not rescue the housing industry from its challenges. Mortgage rates today are still low from a historical perspective. A continued adjustment in housing prices in many markets is almost a cyclical necessity. Inventories in many markets will take at least until 2009 to be worked down to "normal" levels no matter what. An interest rate cut will not reinvigorate the consumer just in time for the holiday season.

The subprime mortgage lending mess and the housing correction are public relations cover for the two reasons that would drive a rate cut. First, the Fed of course has more information and radically different networking insights into the health of the securities markets than the average Joe, or John, and may reduce interest rates based on a more calamitous set of possible scenarios than seem apparent. Rescuing banks is never a good thing, and is always best avoided. Second, systematically weakening the dollar makes U.S. goods more competitive globally and is a boon to exports and to those S&P 500 corporations with multinational operations. Today's surprisingly strong reported growth rate for the economy is largely attributable to this fact, and may bode well for continued good employment numbers.

This is all at the expense of the stature of the U.S. currency. There are many reasons why this is dangerous. Some were discussed in a 9/10 post here. For now, here's just one more example. If a small business or consumer makes money just in U.S. dollars and is not connected to a multinational corporation, their spending power and their savings depend on the value of that dollar. Many goods and commodities are globally priced. So, all things being equal, if the dollar had not declined by 40% over the last five years against a basket of major currencies, the price of a gallon of gasoline, a globally priced commodity, would hypothetically be $2.10 instead of $3.00. That's a big deal, and it's not just confined to energy prices.

In 1962 one of the standard lines inserted into President Kennedy's speeches by his talented staff of writers went something like this---"to be a global leader a strong currency is just as important if not more important than a strong military"---something to think about.


Anonymous Anonymous said...

Fed cuts rates, bond rates rise, dollar falls, stock market falls. This is not working.

3:00 PM  

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