2007-09-19

A more attractive offer

Exactly one month ago I came to the conclusion that oil is likely to go over $100 per barrel. My reasoning was based upon the actions of the Federal Reserve Bank at the time cutting the discount rate, which implied to the market most strongly that the official rate would be cut. Well, it happened - the rate has been slashed by 50 basis points from 5.25% to 4.75%.

The market, predictably, went wild. It's always amusing to see the graphs of market reactions to certain news and last night's Wilshire 5000 went from zero to hero in the space of 15 minutes. Encouraged by the cut, and seeing in it a decisive action by the Fed, the market invested an extra $432.36 billion into shares (based on the rise in the Wilshire 5000)

But, given the gushing and excitement of the sharemarket, one could easily forget to check out other important market barometers.

Perhaps the most important is the US Dollar. While the sharemarket jumped up the Dollar fell down. It went from €0.72 to €0.7157, a fall of 0.6%, admittedly not huge but, then again, most landslides begin with a few pebbles.

When Ben Bernanke informed the market of his desire to print more money in the form of lower interest rates, he did so in a foreign exchange (forex) environment that has become increasingly hostile to the US Dollar. Like all markets, the forex market operates by supply and demand. By increasing the money supply Bernanke essentially told the forex market that money will be cheaper. With demand not increasing, the only thing the forex market could do was to downgrade the currency. This has been happening for some time now, but when the Fed lowered rates it was a signal that more is to come - which means that the forex market can continue to devalue the dollar.

Of course, one of the results of a dollar losing value is the increased price of imports. This has an inflationary effect, which means that the rate cut is inflationary in nature. Given the fact that inflationary pressure have beset the US economy for some 12 months now, the Fed's actions in lowering rates risks increasing inflation (the deflationary effects of a downturn notwithstanding). If the forex market continues to punish the US dollar, the Fed may be in the unenviable position of having to choose between runaway inflation or raising interest rates during a recession.

The second market barometer worth noting is the price of oil. Oil is priced in US Dollars and this price depends upon a combination of supply and demand influences as well as the price of the dollar. In other words, the price of oil does not fall whenever the dollar falls - it increases in value if the dollar falls. And, surprise, surprise, the price of oil spiked after Bernanke's announcement and is now hovering around $81 per barrel.

As the US economy begins its slow winding down, international investors are increasingly beginning to see better offers in younger, more attractive economies. Once a virile peacock, the US economy is increasingly turning into a bitter old rooster. The Subprime meltdown is the beginning of the end of America's most favoured status amongst the world's economies, and the result will be a protracted, painful recession and economic realignment. By cutting rates, the Fed has chosen to make it easy today and harder tomorrow.

11 comments:

Dave Lankshear said...

Of course, one of the results of a dollar losing value is the increased price of imports. This has an inflationary effect, which means that the rate cut is inflationary in nature. Given the fact that inflationary pressure have beset the US economy for some 12 months now, the Fed's actions in lowering rates risks increasing inflation (the deflationary effects of a downturn notwithstanding). If the forex market continues to punish the US dollar, the Fed may be in the unenviable position of having to choose between runaway inflation or raising interest rates during a recession.

This is one reason I wonder what economics would look and feel like if the folks at Federal Union had their way. Imagine the European Union growing across the globe, becoming a World Federal Government setting policy for one dollar. So much of economics would be simplified, the sharing of wealth between nations might become easier and fairer, post-oil infrastructure developed, demographic transition in the 3rd world would halt the population explosion, Labor laws could gradually be standardized lessening the desire for the "poor" to immigrate to the "rich" nations, and world peace a viable option? All right, I just crossed the line into beauty pageant territory... but you can see why a World Federal Union would be interesting.

One Salient Oversight said...

I agree. One of the great things about the EU is that it has an infrastructure fund which builds roads, railways, power and water in places of the EU which have limited access to it. Thus, by becoming a member of the EU, countries like Poland or Hungary are immediately made richer.

But we all know how much the Americans like their independence and hate everything European.

BLBeamer said...

But we all know how much the Americans like their independence and hate everything European.

You say that as if it were a bad thing!

Seriously, Americans do like their independence but they hardly hate everything European. And we are quite fond of most things Australian.

Whatever gave you the impression Americans hate everything European?

Edd said...

A World Ferderal Union would be interesting but we would still be stuck with the same result. A small ruling elite controlling the masses as well as all the world's natural resources. Of course the ruling elite will always be the major financiers of the world.

The EU is a prosperous nation. but the nations that comprise it lost their sovereignty in exchange for such prosperity. Should we endanger our rights and liberties to such an entity? I wouldn't be surprised if it became a movement were nations become conglomerates based on free trade agreements: North American Union, Free Trade of the Americas, United States of Africa. The surprises are yet to come.

One Salient Oversight said...

Whatever gave you the impression Americans hate everything European?

By reading a number of right wing blogs; Freedom fries; Cheese eating surrender monkeys... the list is endless

One Salient Oversight said...

A small ruling elite controlling the masses as well as all the world's natural resources. Of course the ruling elite will always be the major financiers of the world.

Not necessarily. America is controlled by a ruling elite without having a supra-national entity like the EU. It doesn't mean that it always will be, or that a world federal union will do the same. I'm a big fan of Demarchy whereby politicians are picked randomly from the population rather than being voted for.

The EU is a prosperous nation. but the nations that comprise it lost their sovereignty in exchange for such prosperity. Should we endanger our rights and liberties to such an entity?

Many people see their allegiance to being European over and above being German or French. Is that a bad thing? Is it better to be a Californian or a Nebraskan first and American second?

Sovereignty is a man-made concept. If people choose to be less nationalist and more internationalist then it is their choice. The people of Europe weren't forced into the EU, they chose to go in via referendum.

Do people in Luxembourg have greater freedoms than Germany simply because the former is smaller and the latter is larger? Is it better to be an Alaskan than a Californian?

I'm a human being and an internationalist. I love my country but I also have learned to love other countries as well.

BLBeamer said...

By reading a number of right wing blogs; Freedom fries; Cheese eating surrender monkeys... the list is endless

I hope you don't base your opinion on America based exclusively on what you read on right wing blogs (or left wing blogs, for that matter).

Besides, the cheese eating surrender monkeys comment originated on "The Simpsons", I believe. The list is hardly endless, but if those are the worst you have, then a happy future for trans-Atlantic relations is assured.

Like you, I love my country, and appreciate other countries. I believe the vast majority of Americans feel the same.

One Salient Oversight said...

I read both right wing and left wing blogs (more left than right). Al Mohler's blog can be very anti-European at times.

Which state are you from?

BLBeamer said...

I'm from Washington. I've never read Mohler's blog.

By the way, I enjoy your blog.

It's interesting hearing a non-American's view of the US besides my cousin.

Dave Lankshear said...

By the way, I enjoy your blog.

It's interesting hearing a non-American's view of the US besides my cousin.


Hey Beamer, Neil's MY best friend so don't you go flirting with him, he's MINE!

I love you Neil.

;-)

Edd said...

The US is but a shadow of itself. It is not the same republic when the nation was born. If the US and its people would only preserve the ideals of life, liberty and the pursuit of happiness and what the colonists fought for then the United States of America would still be an excellent example of a national government at work.

A one world government would literally have the power to wipe our rights away. You will still have power concentrated to the elite few. How can demarchy can even be possible if power is concentrated by the few, will the elites give up that power because its the right and fair thing to do? The people will not beg for it either. They are too worried about prime time tv, busy living the materialistic life to even bother with such an idea.

I love other countries and its people. I have traveled to latin america many times, but I'm nationalist, "trade with everyone, alliances with no one" pretty much sums up my stance. A one world government is coming but it won't be utopia. Power corrupts and we humans aren't responsible or good for that matter to exercise such power. The only one capable of achieving such a feat and doing it right is Jesus Christ. Only he can rule justly with all fairness and righteousness. To him I give up my nationalism.