Several months ago, I wrote an article, "Checkmate — Fed & Treasury are Cornered," in which I stated that the Federal Reserve's lowering of short-term interest rates would fail to stimulate the U.S. economy and lead to higher inflation.
Since that time, inflation rates have risen substantially, with the consumer price index mounting to an annual rate of 4 percent in March, from 2.8 percent in September 2007. Meanwhile, the prices of crude oil, gasoline, and jet fuel have gone through the roof — all are up 47 percent since Oct. 11.
The inflation in jet fuel prices has resulted in large operating losses at several airlines for the first quarter of 2008:
United Airlines — the world's second-largest airline by passenger traffic — announced earlier this week that it lost $537 million during the first quarter Northwest Airlines Corp. posted a first-quarter loss from continuing operations of $191 million
Delta Airlines reported a loss of $274 million (excluding a bankruptcy-related charge)
JetBlue Airways and AirTran Airways' also reported substantial first-quarter losses
In response to rising operating costs, United Airlines said that it will eliminate approximately 1,100 jobs, reduce its domestic capacity, and raise airline fares. Delta and Northwest made similar announcements.
Apparently, Fed Chairman Ben Bernanke didn't understand the negative consequences that drastic interest-rate cuts would have on the economy. Or perhaps he felt that helping people to stay in homes that they couldn't afford (by indirectly lowering adjustable-rate mortgage rates) was more important than enabling persons who live on a fixed-income to afford to eat, pay their electric bills, and drive their cars.
Yet, the Fed plans to cut its target Fed funds rate once again next Wednesday, according to recent trading activity in the interest rate futures market. If the Fed makes such a move, the value of the U.S. dollar will likely resume its descent and inflation rates will certainly rise even higher.
Such inflationary pressures would likely lead to a continuation of the recent slowdown in consumer spending and would lead businesses to continue cutting back on their capital investments. In other words, the Fed's efforts to stimulate the economy by lowering short-term interest rates will have the opposite of the intended effect — economic growth in the U.S. will likely continue to slow.
Contrary to conventional thinking, my research indicates that the Fed needs to stop lowering short-term interest rates — perhaps must even raise rates slightly — if it really wants to stimulate the economy. Raising rates by a quarter of a point would likely halt the decline in the dollar and even help it rebound.
A stronger dollar would force oil prices lower because oil is priced in dollars. (The slumping value of the dollar means that oil producers have to hike up the price of oil in order to receive the real value of the oil.) That would, in turn, release the noose on business operating costs and free up spending money for consumers. After all, the price of oil is indirectly or directly related to all types of consumer goods, as well as food, electricity to heat/cool homes, and gasoline.
Perhaps Mr. Bernanke and his colleagues on the Federal Open Market Committee will come to this same realization and decide to hold interest rates next week and in the following months. If not, we may be facing an even scarier scenario than recession.
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