An Economic Puzzle

by | Dec 22, 2000 | Archives

You may have read that the fed will start lowering interest rates soon. You may also hear from some that this will stimulate the U.S. economy and cause the stock market to once again boom. Perhaps, but before you get to excited think about these economic facts.

During the long stock market boom which ended last year, the U.S. economy remained very strong. Unemployment was low and inflation remained in check, so it seemed. When prices started to rise, the Fed raised interest rates to calm down what Greenspan called irrational exuberance. Inflation appeared to remain in check.

But there has been one factor that too many people ignored, the U.S. trade deficit. The U.S. dollar remained very strong which allowed American consumers to buy huge amounts of foreign goods at seemingly low prices. These imports dampened U.S. inflation in the short run. But the trade deficit in a way reflects a hidden inflation that could now weaken the U.S. dollar.

During Wall Street's boom the trade deficit did not hurt the value of the U.S. dollar because foreign investors were happy to plow U.S. Bucks they were paid back into U.S. stocks. With U.S. shares tumbling now will they feel the same way?

Here is the economic dilemma. If the Fed lowers interest rates to boost the U.S. economy, will this reduce the value of the U.S. dollar? If so won't this cause foreign good to rise in cost (the answer is yes). If U.S. consumers are hooked on low cost foreign goods (we are) won't this rise be enough (especially with high oil prices) to start inflation. If inflation rises, the dollar is hammered and overseas investors flee the greenback, the Fed, The U.S. administration (ie. George Bush) and the U.S. economy could face deeper problems.

What to do? I explain in my next message and outline why the 500 year prophesy we looked at in my message yesterday (about fools becoming the leaders in the new millennium) looks even more accurate.

Until then, good global investing!