Interest Rate Change Vs US Dollar Valuation
Rising US budget deficits and increasing US trade deficit has a direct impact on the value of the US Dollar, against the major currencies around the world. Especially, those currencies of countries the United States has large trade balances. (China, Japan and India). The rise of US twin deficits (budget and trade) will cause the US Dollar to depreciate against other currencies. From April to May 2006, the US Dollar lost seven percent in value against the yen, the euro and the pound sterling. This increases the price of goods or service, which are imported and lowers the price of goods or services exported (Undermine inflationary concern). When the Federal Reserve raises interest rates, stabilizes the fall in US Dollar, unless countries around the world (Especially China and Japan, which have the largest trade balances with the United States) raise their interest rates or intervene in trading their currency. For example: In 2006, according to US legislatures and manufacturers, believe Beijjing China Government (Largest exporter of goods to the USA) keeps yuan currency deliberately undervalued by as much as 40 percent, making their goods cheaper for Americans to purchase, undermining a competitive advantage over US manufacturers. A stabilizing US Dollar (or a stronger US Dollar) against the major currencies around the world helps encourage foreign investors to purchase equities or hard assets in the United States. Also, higher interest rate, at least stabilizes value for the US Dollar, attracting foreign investments to finance the US budget and trade deficit.
President Bush administration, had previously stated US Dollar is over valued and deserves to be depreciated, subsequently would help lower US trade deficit. Also, Many analysts felt the Group of Seven finance ministers meeting in Washington D.C. on April 21, 2006, were willing to see the US Dollar decline as part of an effort to reduce the global imbalances, including the US trade deficit. However, according to history, when previous President administrations favored depreciating US dollar, certainly helped to lower US trade deficit, but for the wrong reason. When the value of the US Dollar depreciates against currencies around the world, this a double edge sword, by reducing the cost of goods and services which are exported, thus encouraging more sales. Unfortunately, many foreign investors owning US equities and hard assets, including real estate, will gradually with draw their investment, because while US dollar depreciates, the value of their investments decline (Reflecting the exchange rate value). Their actions often follow, domestic investors withdrawing their money or reducing their financial or hard asset holdings. This leads to a slow down in the US economy (including job growth and economic prosperity), and reduces domestic purchases of imports, thus trade deficit decreases. Also, when the value of the US Dollar depreciates, some direct impact occurs, on the value of crude oil, since a barrel of crude oil is valued in terms US Dollars. A depreciating US Dollar may actually place upward pressure on crude oil prices, since foreign investors will earn less on a barrel of crude, when converted back into their own currency value. The slow economic strength in the US economy, certainly can lead to a recession, coupled with climbing interest rates and increased energy prices. Rising prices of precious metals, including gold and silver, will increase some industrial manufacturing cost.
The complexity and history has shown over time, Federal Reserve raising or lowering interest rates often results, in an economic slow down (or recession) or over exuberant economy, which is not sustainable or highly speculative. The Federal Reserve makes their decision based upon economic events that unfold, which can change dramatically over time and influenced by world economic news events. From 2004 till May 2006, the Federal Reserve has increased the Federal Funds Rate by sixteen quarterly percentage points. Keeping in mind, when interest rate changes, effects are not likely to be fully ascertained, for at least six months in the future. The Federal Reserve regards any signs of inflation, as being perilous, and often reacts by raising the Federal Funds Rate or taking other measures to curb inflation. Actually, some inflation is good, reflecting an economy that is growing, for the demand of goods and services, provided consumers have available funds, don’t over extend themselves by borrowing or over extending their credit availability, and inflation increases are gradual or moderate. Certainly, rising interest rates help encourage investors place more of their money in Certificates of deposits, for a higher interest rates or encourage increase savings accounts. When savings accounts increase, banks or financial institutions increase their own investments or have more money available to loan (certainly at higher interest rate). Furthermore, higher savings rate plus congressional and executive credible plan to reduce fiscal deficits, over the long term, stabilize and favors a higher valuation for the US Dollar. Higher rates over time can derail temporarily financial or equity markets. Because, investors eventually realize investing in fixed income securities yield a higher fixed rate of return (guaranteed), compared to the equity investments (stocks), yielding substantially a lower return on investment or offer no guaranty for appreciation in value.
Question: Will higher interest rates reduce the number of borrowers, that will not have the financial borrowing capability to make investments or purchases, which may cause the US economy to slow down or fall into a recession? Always, the consumer is the back – bone of the US economy, which keeps it vibrant or weak.
