As expected, last week the Fed
cut the federal funds rate by one quarter point to 4.5% last
week. This move is obviously in response to the current credit
crunch involving sub-prime mortgages. Psychology does matter,
and these latest moves by the Fed are an attempt to assure
investors that the Fed stands ready to provide whatever help
is needed to avert a financial panic. Citigroup is estimating
that they may have to write off more than $21 billion (yes,
billion) in losses due to investments in sub-prime mortgages.
Other financial institutions are facing write-offs also, and
no one knows how much is left out there. Fortunately, the
rest of the economy remains strong so it is unlikely the credit
crisis will bring down the economy as a whole. Inflation is
still tame at this point (core inflation is running less than
2% on an annual basis) so the Fed is not forced to raise rates.
On the other hand, they are not likely to cut rates further.
As we have stated in the past, interest rates are low by historical
standards and money is plentiful.
The biggest obstacle the Fed faces is the declining value
of the dollar, and lowering interest rates further will only
help push the dollar lower. Many will say (especially in Congress)
that a cheaper dollar is good as it lowers the cost of our
goods overseas and reduces our trade deficit. Cheapening the
dollar is the same as imposing a tariff, and tariffs have
never worked in the past and are less likely to work now with
spreading globalization. In fact, the cheaper dollar (tariff)
is counter productive. Competition sets prices (domestically
and internationally) not currency changes. A depreciating
currency can eventually lead to inflation or even hyperinflation
(Germany in the 1920s) and possibly economic collapse. Deficits
are driven by the business cycle. Exports traditionally outgrow
imports as the economy slows, and when imports grow faster
than exports, the dollar tends to deteriorate. Exports have
actually been higher than imports for over a year which would
indicate that the decline in the dollar is almost over as
there is about a one year lag time. Add to that the fact that
many in Congress and elsewhere are at least trying to talk
the dollar down or wanting to pass legislation to “protect”
the dollar, and you have the recipe for the dollar doing the
opposite (strengthening).
The fact that many countries are reducing their holdings
of dollars is not necessarily an indictment of the US in general.
Low interest rates are making other US assets more attractive,
namely stocks and direct investments in US corporations. We
went through this in the 1980s when Japan was buying out America.
Now other countries (notably China) are flush with cash and
see better investment opportunities here than in our Treasury
bills and bonds. The rest of the world recognizes that the
US is still the strongest economy and has the most stable
political environment in the world. Why wouldn’t they
want to invest here?
The bad news bears. There certainly is no dearth of bad
news out there, and the media seems to delight in focusing
on it. The credit crisis of course is real, but it is being
addressed both by the Fed and by those financial institutions
that are directly involved. The market will correct all the
excesses like it has for all financial panics in the past.
What we don’t need is heavy handed government interference
which will only make it worse. Oil is approaching $100 a barrel
but is not having the same negative impact on the economy
as it would have in the past. The price of oil is being driven
by the burgeoning economies around the globe which can be
viewed positively. General Motors just reported one of the
largest losses ever for a US company ($38.9 billion). However,
they just settled with the UAW on a contract that should make
them more competitive with foreign car makers.
Thanksgiving. The holiday season is once again upon us,
and we have much to be thankful for as a country. Economically
there are many bright spots. The economy grew by a 3.9% annual
rate in the third quarter up from 3.8% in the second quarter.
Employment has expanded for fifty consecutive months, and
we have created 8.5 million jobs during this period. Gross
Domestic Product (GDP) has grown $1.5 trillion over this period,
and the budget deficit is down to $163 billion or 1.2% of
GDP, the lowest percentage in five years.
Of course, we should most of all be thankful that we live
in a country with so many freedoms. One does not have to look
far to see how many people are living under tyranny and have
none of the basic necessities of life that we tend to take
for granted. Happy Thanksgiving everyone.
Random thought for November 2007:
According to former Secretary of Education, Richard Riley:
The top ten projected in-demand jobs in 2010 did not exist
in 2004, and we are currently preparing students for jobs
that do not now exist.
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