Why the Fed's Rate Cut Was a Bad Idea

09/24/2007 12:00 am EST

Focus: MARKETS

Vivian Lewis

Editor and Publisher, Global Investing

Vivian Lewis, editor of Global Investing, says the Federal Reserve’s half-point cut will cause the dollar to plummet and drive up prices of everything for ordinary Americans.

Why do I think the Fed’s move to slash interest rates is such a bad idea? Socks, not stocks, is my reply.

The lower US rates favor holdings in higher-yielding currencies. Last week the Canadian dollar hit parity again, after 41 years. The Euro hit a new high of nearly $1.41, and the yen also rose. The Indian rupee is now worth 2½ cents. A dollar will get you only 1.858 Brazilian reals. The British pound, despite [the bailout of] Northern Rock, is back over $2.01. Interest rates favor all these currencies (except the yen, which is back financing the carry trade).The answer is also coming from the US Treasury market. Longer bonds are commanding much higher yields than short-term ones, steepening the yield curve. This is a sign that the markets expect more inflation (for which holders of longer-term paper must be compensated.) So, why were rates cut so sharply? The US economy is not in any more desperate straits than Euroland or India or Brazil. The rate cut will not so much trigger growth in the US (which the Fed is supposed to be concerned with) as it will weaken our currency (which the Fed is also supposed to be concerned with).

While Wall Street has problems, the crisis is not over stocks but over what is on the books of supposedly clever investment banks that piled into commercial paper and asset-backed vehicles and probably still have no idea how much they hold or what it is worth.

My first concern is that innocent victims of bait-and-switch mortgages won’t benefit from a rate cut at all. Housing problems are not general across the USA and not visible from my perch in Manhattan. They are concentrated in regions where buy-to-let and real estate flipping got out of hand.

And a rate cut does not do much for the jobless. You have to wait for it to result in business optimism leading to new investment and new employment. There is quite a time lag.

In fact, two of the three legs on which our US economy operates are doing fine. Retailers are reporting that high levels of spending continue apace. Auto sales are actually picking up of late.

The weak greenback will hit every American. We will all suffer from the inflationary impact of a weak dollar, the almost inevitable outcome of lower interest rates.

While all Americans will pay higher prices for commodities, those who spend their income keeping body and soul together will suffer most. Anything priced in dollars which does not come from the USA, be it oil or most metals (including gold) will cost more. Socks or cell phones, disposable diapers or dolls, tank tops or televisions, and lots of food will cost more—much more, if I am right.

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