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Why Keeping Low Interest Rates and a Cheap Dollar Won’t Help the Economy

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Many people, including the Fed, believe the key to economic recovery is keeping the interest rates low and a cheap dollar. That’s why the Federal Reserve is buying Treasury bills in an effort to contain rates and enable businesses to get cheap financing.

However, many experts believe lowering interest rates was the key factor in starting the current financial crisis. The idea was good at the time; cheap credit enabled people to purchase more products, afford more expensive houses and fuel the economy. That created the housing bubble. The problem is, that affected the way banks were making money, and banks need to make money! They started the subprime mortgages to charge higher interest and raised fees to compensate for lost profits. See my article, “Mortgage Fiasco and Ninja Crisis”.

Actually, higher interest rates can be a good thing as a long term strategy. If the banks perceive they can start making money again on the bottom line (from offering credit lines to customers) they will start lending money, this time to serious businesses and individuals who can afford paying back. The dollar will rise again, but in reality a cheap dollar is creating a lot of friction with the eurozone countries and Japan, and they are threatening to take action.

Dominique Strauss-Kahn, managing director of the IMF, set out the concerns in the Financial Times earlier this week. “There is clearly the idea beginning to circulate that currencies can be used as a policy weapon. Translated into action, such an idea would represent a very serious risk to the global recovery,” he said. With the euro at $1.40 and the yen below 85¥/$, both economic powers have no choice but to intervene if the dollar takes another dip.

Above all, officials say, the current financial crisis has shifted influence from the richest powers toward Asia and Latin America, whose economies have weathered the recession much better than those of the United States, Europe and Japan. “Other countries are no longer willing to buy into the idea that the US knows best on economic policy, while at the same time the emerging markets have become increasingly influential and independent,” said Kenneth S. Rogoff of Harvard, “Like it or not, we simply have to accept it.”

At the same time the US government, to avoid an international trade war, is again delaying a probe into the Chinese currency control strategy.  Everybody knows the Chinese have been buying foreign currency for decades, keeping the yuan low to boost their exports and competiveness. It is understandable that they want to keep the current situation to avoid a radical change in the Chinese economy. If the US launches a probe into that policy, it has to take action, and that is what the Chinese government tries to avoid.

We need more unconventional thinking to turn this economy around; and the US no longer can think they can do it alone. For every action of the Federal Reserve there will be a counter action by the ECB and the Bank of Japan, and of course from China. We need coordinated efforts to restore confidence in the market so companies start investing again, and especially hiring again.

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About Pablo Valerio

  • STM

    I don’t even understand why this is an issue in the US, though, and why people think low interest rates + (slightly) lower dollar = disaster.

    In the current climate, it doesn’t do anything of the sort – and it’s economics #101 that inflationary pressures such as high consumer spending are one of the main indicators for a rate rise, while a high-value (or over-valed) currency is damaging to exports (which the Japanese are currently fearful of) and therefore to an economy as a whole.

    It’s also worth remembering that the Euro, the Pound Sterling and the Yen have been up and down like yo-yos. Profit taking on the markets, however, is no real yardstick to the genuine value of a currency, unfortunately. Much of the voltaility is simply at the whim of traders. I reckon there should be another, more realistic way of valuing currencies. Won’t happen any time soon, though.

    The British currency is currently up against the dollar but down against the Euro, and the Yen has looked like it’s on a pogo stick for the past year.

  • STM

    zing: “the lower dollar, the return to prominence of our exports… all that seems a pipedream”.

    My experience of Americans is that they are a clever people generally – in a street-wise way – and very quick to work out what works and what doesn’t.

    The fact that some exporters in the US have been capitalising on the falling US dollar and the rising Aussie dollar – at exactly at 1 for 1 at one stage last week and still hovering around 98c – to broaden their exports to this country shows me that people are indeed quick to work it all out.

    It’s been going on for a few years, as the two currencies have gone up and down, and some US exporters have managed to do deals with the two big supermarket chains here, which is almost like getting California on side.

    What I know of exports: Australia is wealthy ONLY because of exports. Our farmers have turned a dry, dusty continent into a food bowl and luckily, the ground here is full of stuff that Japan, China and India want to buy.

    But they’re making a buck by selling it back to us as steel and finished products and on to the rest of you as well.

    It’s easier for us to sell that stuff overeseas when the value of our dollar is down a bit against the other currencies. They buy less when it’s up, but pay more for it, so it’s aa bit of false economy when the Aussie is high. We all understand that here and know a lower value to our dollar helps keep us prosperous.

    It only hurts when you travel to developed countries and want to exchange currency. My experience is that when the aussie dollar is lower, you can still buy just as much at the supermarket and if you buy an Aussie car, you don’t pay anymore. The only noticeable difference is a marginal increase at the pump in the price of petrol and diesel.

    America can easily go back to being a producer nation. It will take some foresight on the part of some larger corporations, however. But it can’t happen while the dollar is too high to support US export markets.

    But anything’s possible in America IMO if people put their minds to it.

    And Pablo, thanks for the reply. The US dollar is still the benchmark, though. The Euro might be doing OK (not that well right now) and the Yen is, well, propped up (and propped down), but the greenback is still the currency against which all others are measured.

    And rightly so.

  • zingzing

    stm: “No mate … the lower dollar can be a godsend. Exports are what bring in the big bucks. That is the America of the past, the wealthy America.”

    stm (and clavos), i understand that. but! you’ve got americans drunk on cheap imports and cheap walmart prices. it’s hard to wean them off. i don’t doubt that a weaker dollar, at least for the time being, is a good thing for us. but it’s a double-edged sword. china is (albeit artificially) weakening its currency to make its exports more attractive. they can produce exports for and sell exports to us cheaply. we like having the stronger currency, at least on the consumer end. because we are a consumer country at this point. it’s only now that the economy has tanked that we’re like “wait a minute…” but maybe it’s too late. we don’t produce like we used to, and maybe we don’t want to anymore.

    also, the ford situation is much more simple than what we have going on now. ford’s money went to his workers, who then became his consumers. and ford’s money stayed in america. once it’s out there in the global economy, things get a little more loopy and strange. the way i see it, which i’ll admit is with a limited understanding of economics, money starts doing counterintuitive things out there in the wilds of international finance and commerce.

    my basic problem, in the end, is that i doubt we CAN go back to the way it was, to stm’s “America of the past,” the producer nation. our products cost too much to make and aren’t cheap enough to export OR to sell to our cheapass american selves. we’ve become a victim of our own greed.

    the lower dollar, the return to prominence of our exports… all that seems a pipedream.

  • Thanks for all your comments. My intention writing this article was to encourage discussion about the wisdom of spending billions to keep the currency and interest rates down.
    We tend to forget that the Dollar is no longer the Global Currency. The Euro, the Yen and the Yuan are very strong and many corporations trade in those currencies when not dealing with the American market.
    When the Dollar goes down against the Euro Oil goes up, and other commodities too.
    America can not manufacture in volume anymore, they have outsourced everything to Asia.
    US administratrions saw this in the past and encouraged the US businesses to focus on high-tech, science and education to create a workable service industry.
    If we just try to focus on currency control we may see ourselves in a global currency war soon. It might be wiser to go back to import tariffs and trade regulations.

  • Clavos

    the american worker might benefit, but what of the american consumer? and which is more important?

    Neither. They’re one and the same, zing. That was the principal Henry Ford was working with when he raised his workers to $5 an hour and caused such an uproar from his competitors.

    And it worked — magnificently.

    Because the workers ARE the consumers.

  • STM

    No mate … the lower dollar can be a godsend. Exports are what bring in the big bucks. That is the America of the past, the wealthy America.

    It’s how the US and Britain became the two richest nations in modern history: You control the supply of raw materials coming in, and then make stuff – or produce stuff, or provide services – and sell these things at a profit.

    That’s not really happening the way it once was and the shift is a very huge shift that has almost happened by stealth over the past 50 or 60 years.

    Like I say, the US is heading towards becoming a post-industrial society. That is OK and bring big rewards in a smaller, more manageable econonmy. But in a country with nearly 300 million people that is already outsourcing many of its manufacturing jobs, it’s a disaster waiting to happen.

    Also, there is simply no consumer confidence in the US at the moment. People won’t spend because they don’t know what’s around the corner.

    And it doesn’t matter if they spend on credit, provided they have the means to pay it back.

    But there’s no point just coming out of a recession and putting up interest rates. The economy is about people mostly … the key is to encourage people to spend in this climate, not squirrel away a couple of nuts in case the long winter is longer than expected.

    Once that happens, and people really start dipping into their pockets and spending across a whole of sectors, interest rates can go up.

    The low dollar, however, is something else, and not just because it enables the US to pay back some of its debt more cheaply – and it is certainly something that smart business people can use to boost their businesses and profits and create more American jobs.

    The glass is half full at this point, rather than half empty.

  • zingzing

    but do they care at walmart?

    the american worker might benefit, but what of the american consumer? and which is more important?

    seriously, the comings and goings of money is a bit of a mystery to me. what seems like a bad thing (the decline of the dollar) becomes a good thing, then it becomes a bad thing all over again if it goes too far. i simply don’t know.

    thing is, i don’t think anybody really knows. shit floats on rumors and drowns in panic.

  • STM

    Here’s something very tangible on that score.

    Forgot to mention too: With the Aussie dollar higher and the US dollar lower, Aussies are spending a fortune on-line with US based companies.

    It is currently cheaper for me to buy online from the US and have it delivered across the Pacific than it is for me to buy the equivalent goods in Australia and drive them home a few kilometres in the car.

    That can only be a good thing both for Americans AND Australians.

    It’s also indicative of how a lower greenback helps American profits, and hopefully goes on to provide more Americans with jobs.

  • STM

    You are only half right, I reckon; while it’s probably a good idea to move interest rates up a couple of basis points in the US in the not-too-distant future (there are very few inflationary pressures that would justify it at the moment), I don’t agree about the dollar’s value.

    In my view, it’s been artificially high for too long. It’s been the benchmark currency on Wall Street, where there have been many advocates of of the philospohy of “king dollar”.

    That might be OK for traders wanting to make a big quid on the currency markets, but it does a huge disservice to American industry and producers.

    Part of the problem for the US is that it’s now very quickly on its way to becoming a post-industrial society; US producers wanting to open up export markets have been unable to do so in recent years in sufficient numbers, because the value of the dollar makes US goods unaffordable in too many markets.

    In the not-too-distant past, US goods have been sought after because of their affordability and their quality.

    Any slight differential in price might have been outweighed by the better quality on offer, but that has not been the case for some years. Corporate complacence is largely to blame for the way that scenario has played out.

    Compare, for instance, the quality of luxury cars made in Europe and the US. If you were looking at markets in the mid-east, for example, the Europeans win hands down.

    Globalisation and global parts bins have been both a godsend and a millstone. For instance, many GM exports to the mid-east are actually Holdens rebadged as Chevrolets and built in Australia (where exporting motor-vehicle manufacturers – who see these kinds of exports, including to places like Brazil, as the cream on top of the bread-and-butter local market – are now starting to panic a bit as the Aussie dollar hits parity with the greenaback).

    It’s hugely indicative of the problems American workers currentlyb face. Jobs go offshore as doubts about US price and quality and the ability to produce goods that strike a chord with domestic and overseas consumers hit home with buyers both in the US and overseas. One good thing about the GFC is that it shook many top executives in the US out of their jobs – or their lethargy. Big corporations run themselves in the good times, but you can’t play golf and cross your fingers when the ice-cream is hitting the fan. Poor management is to blame for much of what has gone as much as changing global circumstance.

    But you don’t have to look as far afield as Australia or the mid-east to see where the problems lie. Go to any US department store and see the T-shirts made in China with American labels. Everyone knows that manufacturers everywhere, not just in the US, are rubbing their hands together because they can produce a shirt in China at a fraction of the cost they can at home, and still charge a price close to the level they charged when the goods were made in the US. American trucks made in Canada and Mexico are another example.

    Profit is king, but unfortunately, it is a pretender to the crown in this case because it takes manufacturing and producers’ jobs out of American hands.

    If the US wants to restore its place in the world, it needs to do what it is really good at: make or produce things that others will be falling over themselves to buy. That is, stop hiving off jobs to foreign workers. The only way this can be achieved is with a lower dollar.

    It won’t have an effect domestically in terms of what Americans can buy at the supermarket or the Ford of GM showroom. And a lower dollar will still buy the same size grocery basket if Americans buy goods produced locally.

    The only real downside will be slight increases in the cost of fuel and for Americans travelling overseas and getting less bang for their buck – but only when they’re travelling to other developed nations and exchanging their cash for higher foreign currencies.

    The US became wealthy doing what it is best at: making good stuff and selling it to a huge domestic and international market. Unfortunately, you don’t make a nation wealthy by moving virtual bits of paper around on Wall St (it only lines the pockets of traders, shareholders and corporate bigwigs), but unfortunately the opposite is not true as we have seen over the past few years.

    I can tell you that in the past few years in Australia, we are starting to see more American goods and produce for sale at very competitive prices.

    US-built cars have been making some inroads because prices are more competitive than they have been for decades. My wife now regularly buys at the supermarket in Australia US fruits and nuts in the off-season, with the southern and northern hemisphere seasons being directly opposite.

    A friend recently bought a US-built car, which he loves. I don’t like it as much as he does, but there’s no accounting for taste. And he’s not alone in that. Jeep currently has a huge sales/marketing campaign in Oz … offering buyers “more bang for their buck”.

    The fact that US manufacturers and producers are being proactive and identifying these markets should be a comfort to Americans, but less isn’t more in this case and many others should be doing so if they want to keep the US economy buoyant.

    It’s unlikely that there would be a lot of these sales in countries where the US dollar is still high compared to local currencies, but exporters in the US are looking at markets like Australia/New Zealand and of course Canada and Europe, where they can compete and consumers can afford to buy. Bumping up sales of cars to South America looks good on paper, but it doesn’t always help the balance sheet if huge discounts mean barely breaking even.

    Americans need to educate themselves to the real value inherent in a lower dollar, and see it for the good thing it is.

    It might sting a bit in collective national ego terms, but American ego really is a dirty word in this case.

    And I am a great believer in keeping it all simple; making what money there is go around locally.

    Even something as simple as buying your lunch in a local diner keeps another American in a job, and keeps another American spending money in America that has been earned in America.

    And when more Americans ARE spending – in America – and there is some inflationary pressure on the economy, that’ll be the time to put up interest rates. Not before.

    In the meantime, US exporters should make hay while the sun shines with the dollar down slightly against other currencies.

    The old story and the one business strategy that has never been altered by bullshit and corporate wank-speak:

    The best way to get rich is to make something that someone else wants to buy and, importantly, can afford to buy – and then sell it at a profit.

  • There is an interesting video: “Money as Debt” by Paul Grignon
    It was made before the financial crisis, and explains the way banks “make” money

  • Anarcissie

    I believe that low interest rates (indeed, subzero interest rates, since they are lower than inflation) are a symptom rather than a cause of our present economic problems, which I think stem more generally from deindustrialization and decapitalization. Low interest rates, in effect creating funny money for the rich, and debt, were used to mask these problems, but could do so only temporarily. Attempting to reinflate credit money, that is, to reconstruct the mask, are not going to work for very long. I think we are going to have to bite the bullet, as they say, starting with giving up our lovely empire.

  • Just read in the WSJ China is rasing interest rates, to 5.56%, to contain inflation… looks like they have no problem with a slow economy..

  • @Baronius

  • Baronius

    This is a really smart article.

  • @Kurt: what is your point?
    The banks are not lending more money because they can’t make enough money doing it, so they concentrate on fees and high interest products such as credit cards.
    Property prices are still inflated, and the issue are not interest rates, are jobs!

  • kurt brigliadora

    What?…Tell that to the NAACP…When people could’nt qualify for a loan; they would shot”discrimination” So Bush opened up the flood gates…along with ; Jackson and Sharpton.

  • kurt brigliadora

    Low interest rates…Need to be lower to start people “buying and selling” again! the higher the rate , the less you get for your property.