Tuesday, January 22, 2008


Damned if you do; damned if you don't:

So now the Federal Reserve has weighed in with a 3/4 percent cut in the Federal Funds rate. Even though commercial banks followed suit, lowering the prime lending rate by a similar 3/4 percent, the stock market showed how much good that move would do, dropping almost 300 points at the opening bell today--about what it had been expected to do even without an interest-rate cut.

There was one place where the Fed's action did have an impact though: the exchange value of the dollar in foreign currency markets. No sooner was word of the interest rate cut announced, than the dollar fell against major currencies like the British Pound, the Euro and the Japanese Yen.

And there's the rub. The Fed is in a trap. It cannot cut interest rates much more without causing a collapse in the dollar, which, because of the huge US trade imbalance, and all those consumer goods and raw materials--especially oil--that are imported--would lead to serious and politically dangerous inflation. And there is another constraint: with the current rate cut, the US now has the third lowest interest rates in the world. If the Fed makes another cut, as it has hinted it might in a week or so, only Japan would have a lower interest rate environment than the US. That makes the dollar a very undesirable currency for foreigner investors, which means they won't want to hold dollars, and they won't want to hold US stocks.

Yet if the Fed doesn't cut interest rates even further, the stock market will continue to plunge, which again discourages foreign investors from pouring their money into the U.S., which in turn puts downward pressure on the dollar.

This was all predictable.
Yes, unfortunately.

Plus: How bad can it be?