The Federal Reserve is on a mission. By slashing interest rates, you
may get the impression the Fed is out to save the economy. Instead, it
is trashing the dollar.
It now costs almost $1.45 to buy one
euro. It costs $2.08 to buy a British pound. Gold is $800 per ounce,
and oil, which is denominated in dollars, costs more than $95 per
barrel. There seems little doubt that we will soon break the dreaded
$100 mark. One hundred dollars is exactly the price Osama bin Laden
suggested the West should be paying for a barrel of oil soon after he
attacked America on Sept. 11, 2001.
Investors, however, are
cheering as the Fed devalues our currency. The Dow rallied 138 points
in response to the latest interest rate cuts. The Fed reduced the
discount rate by a quarter point to 5%. At the same time, it reduced
the fed funds rate by a quarter point to 4.5%. With oil and gold prices
near record levels, you might think that reasonable people would expect
stocks to be struggling a bit. Reason, however, seems to be in short
supply on Wall Street.
The Fed justified its latest rate cut
by saying that economic expansion is likely to slow in part due to the
housing correction. Furthermore, it said core inflation readings have
improved. Apparently, no one at the Fed drives a car, buys food, or
heats his home.
Those who have mortgages that are about to
adjust to higher levels might want to send the Fed a thank you card.
The Fed has given them an opportunity to switch into fixed-rate loans.
Unless significant penalties are involved, refinancing in this manner
should payoff over the long term.
The Fed’s action came the
same day the Department of Commerce released its advance estimate for
third quarter GDP. Although the figure is subject to revision, growth
was a much stronger-than-expected 3.9%. It is no surprise that exports
contributed to this growth. They surged 16.2% because the weak dollar
makes American goods cheap abroad.
With growth near 4% it
seems odd that the Fed would risk inflation by cutting interest rates.
Core inflation may be tame, but headline inflation is not. The Fed is
obviously looking ahead, and apparently it does not like what it sees.
It may be worried that the sub-prime mortgage mess has not fully
settled. It may also be concerned that consumer spending will
eventually take a hit. Consumers, however, are weathering the housing
bust and high oil prices fairly well.
But consumers don’t buy
crude oil. They buy gasoline and heating oil. Despite high crude
prices, gasoline prices have remained well off their spring highs. But
how much longer can that last? Either gasoline prices must rise, or oil
prices must fall. Gasoline inventories may fall in coming weeks as
refiners start producing more heating oil. And with Thanksgiving just
around the corner, demand for gasoline is likely to rise. Don’t be
surprised if gasoline prices surge 20 to 30 cents per gallon by the end
of this month.
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