Posted on 08/24/2007 3:56:39 PM PDT by Toddsterpatriot
Rate increases have rarely constituted “tightening” when it comes to restoring the greenback’s value.
The Federal Reserve’s change in bias last week toward cutting the federal funds rate, along with its half-point cut in the discount rate, offers an opportunity to test the widely held belief that rate cuts weaken the dollar while exacerbating existing inflationary pressures. In truth, the opposite is typically the case, since dollar-demand shifts when the Fed acts.
Last week, the market response to the Fed’s new course was profound: Gold began a new short-term downtrend. The dollar adjusted for gold started a short-term uptrend compared with the euro adjusted for gold. The 30-year Treasury yield began a short-term downtrend. And the Russell 2000 Index — comprising small-cap companies and arguably the most sensitive equity index to monetary policy error — ended its recent short-term downtrend.
Overall, lower gold prices, a stronger dollar against the euro, lower long-term bond yields, and rising equity valuations are indisputable hallmarks of a disinflationary environment — not a resurgence of inflation.
The 2004-06 rate-hike experience, compared with last week’s Fed easing scenario, is only a small episode in the longer-term dollar response to interest rates, dating back to the beginning of the post-Bretton Woods era of the early 1970s. The dollar lost 67 percent versus gold between 1972 and 1975, despite the fact that the Fed hiked rates from 3.5 percent to 13 percent in that period. When the Fed reversed course in 1975, lowering its rate target from 13 to 4.75 percent, gold actually fell 23 percent. When the Fed raised the funds rate all the way to 14 percent in 1980, rather than strengthen, the dollar fell, driving the price of gold from $150 an ounce to an all-time-high of $892.
Just as tax increases don’t always yield commensurate revenue increases due to a downward shift in economic activity, interest-rate hikes frequently fail to enhance dollar demand. In historical terms, rate increases have rarely constituted “tightening” when it comes to restoring the greenback’s value.
A case in point came at the tail end of Alan Greenspan’s tenure as Fed chairman. Greenspan is frequently blamed for keeping the fed funds rate too low for too long, in such a way that the dollar lost value. But the dollar price of an ounce of gold tells an entirely different story. Gold hovered in the high $300s while Greenspan held the fed funds rate at 1 percent between July of 2003 and June of 2004. Gold only began to rise once the Fed began raising rates that June. After 425 basis points of rate increases, gold has risen nearly 70 percent.
The significant rally in gold during the past three years understandably caused many to call for even more significant rate increases in order to quickly defuse budding inflationary pressures. But the systematic freezing of credit during the last month has forced the Fed to ease, causing financial markets to respond to the real prospect of a lower interest-rate environment.
Targeting higher interest rates to combat inflation is very much a Keynesian concept whereby central banks seek to reduce economic activity as well as prices. Contrary to current Fed objectives, the surest way to decrease dollar demand and ultimately cause a net excess of dollar liquidity that would spark new inflationary pressures would be to target the economy for slower growth with higher interest rates.
Looking ahead to September’s Fed meeting, if the FOMC lowers the funds target, media accounts will suggest a looser stance on the part of policymakers, while an increase will be described as a monetary tightening. In truth, a Fed ease will point to dollar strength and a budding disinflation.
— John Tamny is editor of RealClearMarkets, and can be reached at jtamny@realclearmarkets.com. Paul Hoffmeister is chief economist at Bretton Woods Research, and can be reached at phoffmeister@brettonwoodsresearch.com.
Because increased stimulation of consumer demand leads to increased revenue. Now are you honestly arguing that long term deficit spending is sound economic policy or that it leads to the strengthening on the dollar?
The charts showed that even as the deficit increased under Reagan, inflation dropped. The opposite of your claim.
Now are you honestly arguing that long term deficit spending is sound economic policy or that it leads to the strengthening on the dollar?
No. I'm honestly showing that your claim was wrong.
You claimed that it did. I asked you for proof. Did you find any yet?
I presented my theory. Present yours.
Reminds me of my contrarian thinking on monetary policy. The credit system is nearly completely stuck right now.. so much half dead companies and mortgage crap blocking the pipeline.
I think trying to cut interest rates will end up having the opposite effect. Money supply slowing down, ala Japan. And the deflation cycle.
My solution.. raise the rates until savers and investors start plowing money back into the market, tempted by the fat return. It will have the effect of dropping a MOAB on all those walking dead companies and bad loans to them and borrowers in over their heads.
But once the MOAB detonates we’ll get a big wave of bankruptcies.. but then when the rotting, half dead, diseased companies are gone, in their place the strong companies will expand, and new companies will rise up. And with the dead crap blown to bits, the water in the pipeline will start flowing just fine again.
So how much unemployment and shrinkage in GDP should we be willing to suffer to see if your idea is a good one?
I'm not sure to be honest, and Bernake would have to have huge balls to do that. Even myself armchair reserve chairman here.. its scary even thinking about it. My biggest fear is that the big money center banks have to be able to survive, or at least a couple of them. Which hopefully it will be citigroup as I bought shares in them mid-last week! Thinking once the weak die, the few big banks left standing should be able to charge fat spreads.
If the system is so bad it can't survive, then we might have to cut rates. My problem thinking about that seriously is I don't see how lower rates would get the foreign investors and americans to invest. So the solution then would appear to me to go for a Japan style... Massive, massive government borrowing.. and I would personally add fed governmetn printing money.. devaluing the currency seriously. For example if the USD fell 50%, a lot of manufacturing would be very attractive here. Why if you are in some third world country buy an imported Chinese car, when you can buy an American for almost the same price, yet American relatively good quality.
But I think the market would have problems with no actual savings coming into it, just new cheaper debt, rolling over older more expensive debt. But then those walking dead companies would seem to me to kill the pricing pressure of the healthy.
The point in this article that lowering the interest rates tends to be correlated with a rising dollar.. is a fascinating point. But I would say isn't that symptomatic of less new dollars coming into circulation aka less borrowing. The US actually needs our dollar to fall in value not rise! Well sorry to ramble on, but its all very complex and inter-related. Bernake is clearly the man of the hour for these next few months at least.
Only if the money is printed, not borrowed. Otherwise, I don't see an inflationary impact.
I have serious reservations about our current policy of deficit spending, however. I can't see how it's going to work to our benefit.
I have never said our deficit spending is a good idea. That's different than saying the spending is not inflationary.
We're not all that smart. This econ stuff can't be all that complicated if guys like us can follow it, the problem we got here is most likely that we're not explaining it right. Here's my shot at it.
Governments can get money in three different ways; by taxing, borrowing, and by printing money. Our gov't gets most of its money by taxes and it meets the shortfall by borrowing. These two methods do not increase the amount of money the country has, we just move a fixed amount of money from one set of pockets to another. Inflation only happens when there's more money chasing after the same amount of goods, which happens either when more bills get printed up or when interest rates are too low and a lot of money gets loaned out. This has nothing to do with federal budget deficits.
OK, what we're saying here is totally different than everything you've ever been hearing on NPR and CNN. That's fine because those guys are idiots and we're not; they're wrong and we're right.
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