And the 75 basis point cut in the interest rate last week follows the 100 basis point cut in the second half of 2007 points out to something larger. That is simply because it is actually in the grip of a recession. The Bush administration may not openly admit it, yet there are tell tale signs of the US economy going the Titanic way. The cut in interest rates are conclusive proof that all is not well within the US economy. That it implicitly makes investments into the stock markets attractive is incidental to the scheme of things. After all where is the question of returns when the principle itself is endangered?
“Naturally I am intrigued at what the US fed is attempting,” I confessed at the outset to Mr. Anand the expert on global economics and the expert on currency movements. “Narada, the Fed by such steep cut in the benchmark interest rate clearly has sent a message – things are terribly wrong with the US economy. But crucially no one has thought about the US Dollar.” I was appalled at the very suggestion. I froze. Is Anand trying to intimidate me? As thoughts raced my mind, I regained my composure and asked him the question – what is the connection? “Narada, my worry is that that US economy is now no longer competitive except in high end technological items. This coupled with the gargantuan US deficits means that the US dollar has been on the decline for some time now.” “So?” I butted in. “Yes let me elaborate,” Anand quipped, perhaps with a tinge of irritation of having been interrupted and went on to add “Narada, the US Dollar has been quoted at 1.30 to an Euro a few months back. Now 1.45 dollars gets you one Euro. Ditto with Yen as it is with the Rupee.” “But were not the benchmark US federal interest rates at 5.25% in the middle of last year, just before it embarked on this steep cut?” I enquired more with an intention of trying to pose before Anand. Strangely Anand seemed to accept that bit of statistics. “Narada, you are correct. When the interest rates were as high as 5.25% within the US, even then the US dollar was falling and the US was failing to attract global capital into the US. Now with the interest falling to 3.50% within the US, one thing is certain – Ben Bernanke may have been able to save the US economy, one is not sure as to the US Dollar.” Once again I gave a blank state. Seeing my predicament Anand explained: “Narada, the issue is that the US requires something like 3 billion US dollar every day to fund its huge trade deficit of 900 billion dollars. Should capital move away from US Dollar to some other currency, just because the interest rates in other countries are higher, the dollar could be doomed.”
Now I recalled the elementary economics that was taught in my high school decades back - a weak currency has the intrinsic potential to trigger inflation. And should the US dollar go down, it could create inflationary pressures within its economy. “And should inflation rear its ugly head then the Fed would raise the interest rates,” I summarised the situation to Anand. Anand was amused at my fallacious understanding of economics. “Narada, it is not as simple as you state. If the interest rates are raised once again, it would mean collapse of its financial sector. That is why these cuts were effectuated in the first place.” And from what Anand said, I surmised, it was a classical case of being doomed or getting damned. Will the US Dollar be doomed or will it be dammed?