Recently, I have been looking at the papers and online news sources and all are saying the same thing–that the U.S. currency is falling in value relative to other currencies, most notably the Yen, Euro, and the British Pound. What I don’t understand is that the Fed, which will meet on Tuesday, is likely to leave interest rates at 5.25 percent. Maybe they see the current inflation rate as a blip on the radar and that in the future, the economy will stabilize so the interest rate doesn’t need to be raised. However, all over the news is the issue with the recently turbulent stock market and the rising loan defaults for subprime mortgages, which are taken out by people with weak credit. I tend to side with the worries of investors, many of whom feel that a recession may soon be felt. In addition, China stated recently that it will start investing some of its $1 trillion reserves, which it claims will not affect the price of the U.S. Dollar. Because a lot of foreign investments are building up in China–causing the foreign reserves to increase $20 billion monthly, China is faced with the dilemma of too much money in the market, something its central bank is combatting by selling bonds every month to reduce market pressures. With all of this said, I would like to return to my opening remarks as to why the Fed is thinking of leaving the interest rate at its current level. Why aren’t interest rates going to be changed to counter the inflationary tendencies and fall in the U.S. Dollar relative to other currencies to make our domestic economy more attractive to foreign investors?
On a side note, the current Israel exchange rate is 1 USD = 4.209 ILS. Below is a look at the ILS over a 3-month period courtesy of Yahoo! Finance:
March 21, 2007 at 11:35 pm |
This is a really interesting issue! I don’t exactly have the answer to your question but after trying to match your observations to an article I previously read, I have derived some questions of my own.
An article, “China’s Rate Boost Shows Economy’s Vigor” from the Wall Street Journal on March 19, 2007, Page A2, discusses an increase in Chinese interest rates. Recently, the People’s Bank of China increased the one year lending rate to 6.39 percent and the one year deposit rate to 2.79 percent (an over all .27 percentage point increase). Although this seems like a trivial augmentation (just over a fourth of one percentage point, what!?) the central bank is hoping it will have big ramifications for helping the economy grow quickly, but also smoothly. The goal of this interest rate increase is to temper investment, by strengthening the costs of borrowing and investing in stock. Rather, Chinese will have a greater incentive to save. It may also relieve inflationary pressures that are coupled with rapidly growing annual rates of GDP. The article discusses yet another factor that arises from the increased interest rate: the rate will allow the yuan to continue strengthening against the dollar, thus enticing more foreign investors.
Now, here is where my readings really start to align with your observations. China now has more than one trillion dollars worth of foreign reserves (which just goes to show how weak the currency and how cheap its exports have been). This overwhelming stock of money is definitely a factor which could encourage inflation as banks lend more. I understand how raising the interest rate in China may combat this inflation but, as you found in your research, why would selling more bonds represent a stabilization policy?
Also, in regards to the U.S. interest rate, this article explicitly states, “[...] economists predict U.S. interest rates will be lowered this year, amid concern problems in the U.S. mortgage market and elsewhere in the economy could hamper growth.” By decreasing the interest rate, the fed would stimulate the economy by increasing domestic spending, however, as you have pointed out, this does not seem to be beneficial to domestic rates of inflation, nor does it exactly scream at foreign investors. So what’s the deal? Should I move to China!?
March 22, 2007 at 12:06 am |
Thanks for the follow-up with an article that you discovered about China’s reserves. Going back to your point about the U.S. interest rates, I guess the FOMC has to determine whether they feel that the inflation rate or the default of the subprime interest rate is the bigger issue. If it’s inflation, then the interest rate should be increased; however, if it’s to solve the subprime interest rate, then the FOMC needs to consider lowering the Federal Funds Rate to make it cheaper to borrow and assist those who have weak credit and are subjected to the subprime rate.
April 4, 2007 at 8:58 pm |
I can’t help but think that although we should fight inflation against other currencies, there is most likely a domestic issue overshadowing this international one. (just as you say in your comment, brandon). It makes me smile when I think about something Liz said at the Alumni Dinner. She was talking about how when the Fed governors have to make decisions about raising the interest rate or whatnot, that basically what happens is they all sit around a big table and just duke it out–each one with his own theory about what is important & what should take presedence–and ending with someone basically winning the discussion. So sometimes it’s just about who has the loudest voice at that table as to whether rates are increased or not….