An Economic Puzzle

by | Jan 26, 2001 | Archives

The Fed has lowered interest rates, but the economy continues to slide. We shouldn’t be surprised or worried as I recently wrote.

A couple of weeks ago I sent my International eClub readers a message warning that the Fed would cut rates but stock markets might not respond. Here is what I wrote.

“Here’s An Economic Puzzle. You may have been reading that the Fed is worried about recession and will lower interest rates soon. You may also hear from some advisors (especially those trying to sell you shares) that this will stimulate the U.S. economy and cause the stock market to once again boom. Perhaps, but before you get too excited think about these economic facts. During the long period of economic growth, inflation seemed in check. When prices started to rise, the Fed raised interest rates to calm down what Greenspan called irrational exuberance. Did this work?

Seemingly, but too many people ignored the U.S. trade deficit. The strong U.S. dollar allowed American consumers to buy huge amounts of foreign goods at low prices. This dampened U.S. inflation in the short run. The trade deficit is hidden inflation that now weakens the greenback.

During Wall Street’s boom, the trade deficit did not hurt the dollar because foreign investors plowed bucks 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 weaken the U.S. dollar? If so, won’t this cause foreign goods to rise in cost and put pressure on inflation? If inflation rises, the dollar is hammered and overseas investors flee the greenback, the Fed, the U.S. administration (i.e. George Bush) and the U.S. economy could face deep problems. The U.S. dollar is already tumbling as I write and at least three factors could push it down 10% or more versus the euro over the upcoming months.

The first factor is that U.S. leaders who will lead us now obtained power (or perhaps impotency) on the wrong-footed notion that they will spend a huge U.S. surplus improving Social Security, Medicare, Medaid etc. This idea is wrong for several reasons. More Americans may become poorer than anyone realizes. The U.S. savings rate is now below zero. More and more Americans have plowed savings into stocks instead of CDs or bonds. The U.S. market has already wiped out huge amounts of savings so less tax will be collected. Social spending will rise. The second factor is the U.S. population is rapidly becoming less healthy. USA Today (December 15 page 2A) reports on the National Health and Nutrition Survey, which shows 61% of all Americans are now obese (30 pounds or more over healthy weight).

The number of adults has nearly doubled since 1970. This fact alone could destroy the federal budget. Third, the dollar has risen steadily versus the euro since the euro’s inception. This trend has now reversed.

There could be a loss of confidence in the greenback. Where to invest if this is true? Precious metals may be one place. A short in the Japanese yen may be another.

But there are other problems, which I will share in my next message that will come to you next Tuesday. Until then, good global investing!