Tags: Fed | and | Treasure | Concern

Check Mate — Fed & Treasury are Cornered

Thursday, 25 Oct 2007 04:43 PM

In a couple of articles that I wrote last week, I mentioned that both the Federal Reserve and the U.S. Treasury Department are currently in a difficult position with regard to interest rate policy and the deteriorating value of the dollar.

Let's first review the Fed's predicament.

If the Federal Reserve continues to lower short-term interest rates, foreign investors will be inclined to sell their low-yielding U.S. Treasury holdings and invest their excess reserves of dollars in securities that pay higher yields — namely, the debt securities of other central banks. Therefore, the value of the dollar would continue to decline against other world currencies and inflation in the U.S. would rise.

If, on the other hand, the Fed raises interest rates (to fight inflationary pressures), there's a good chance the U.S. economy would enter a recession. That's because an increase in borrowing costs would lead both consumers and businesses to cut back on their spending and investments.

Lastly, if the Fed leaves short-term interest rates unchanged, stock prices would fall sharply because most investors are counting on the Fed to continue lowering rates. (A company's stock price is ultimately determined by the present value of its expected future earnings. Hence, when interest rates fall, the discounted value of a company's future earnings rises).

So, as you can see, the Federal Reserve is currently between a rock and a hard place — any interest rate move by the Fed likely will have negative economic and financial consequences.

Now, let's consider the Treasury's dilemma.

European central banks recently began pressuring the U.S. Treasury Department into taking actions to halt the dollar's descent. They've done so because the declining value of the dollar is making foreign goods more expensive to Americans.

As a result, European officials are becoming more and more concerned that their exports to the U.S. will decline in the months ahead. That would, in turn, threaten economic growth in the U.K., France, and other European countries.

If the Treasury were to act in concert with European central banks to halt the dollar's decline, the growth in U.S. exports would slow considerably (and perhaps even decline) because U.S. exports would be more expensive to foreigners if the value of the dollar were to rise.

Hence, economic growth in the U.S. would slow even further, because the U.S. has been relying on exports to compensate for a significant decline in contribution to growth by the housing market.

Second, any actions by the Treasury to prop up the value of the dollar would likely be met with resistance by China because the U.S. has been pressuring China to let its currency float freely against the dollar.

If, however, the Treasury fails to take actions to halt the dollar's decline, inflation would get out of control.

So, as you can see, the massive U.S. trade deficit has backed the Treasury Department into a corner.

Because both the Fed and the Treasury are well aware of their predicaments, I expect the Fed to remain on hold at its next interest rate meeting on Oct. 31 and the Treasury Department to work in concert with European central banks to halt the dollar's descent.

Such actions would help to contain inflationary pressures because the dollar would probably stabilize. In addition, oil prices would stabilize because oil is priced in dollars. However, neither of these actions — nor any other action taken by the Fed or the Treasury Department — will be able to prevent a continued slowdown in U.S. economic growth over the coming months.

So, as I've mentioned on numerous occasions in the past, I urge you to stop listening to all of the nonsense propagated by the self-serving money managers that regularly appear on CNBC and other financial shows. My research continues to indicate that stock prices in general are headed lower.

Fortunately, you now can now easily profit from a declining stock market by investing in the right ETFs.

For example, both our recommended ETF portfolios in our new investor service, The ETF Strategist, appreciated in price last week — when the major stock market indices fell. Our conservative picks rose 1.7 percent, while our aggressive plays advanced 3.3 percent.

Our top three ETFs gained 4.2 percent, 9.2 percent, and 11.4 percent respectively. In fact, all but one of our 8 recommended ETFs gained in value last week while the Dow Jones Industrial Average fell 571 points (or 4.1 percent).

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DavidFrazier
In a couple of articles that I wrote last week, I mentioned that both the Federal Reserve and the U.S. Treasury Department are currently in a difficult position with regard to interest rate policy and the deteriorating value of the dollar. Let's first review the Fed's...
Fed,and,Treasure,Concern
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2007-43-25
 

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