You would have to be living under a rock not to have heard that the Fed cut both the overnight lending rate and the discount rate by a full 50bp (.5%) on Tuesday. Once again I was wrong in my prediction. I really didn't think that they would cut by more than 25bp. This also means that I was wrong when I predicted that the overnight rate would remain at 5.25% until the end of the year. Furthermore, it looks like now I will be proven wrong about my prediction that the Dow would stay between 12K and 14K until the end of the year (14K will likely be broken next week).
Right on cue, the dollar is taking a pounding dropping to an all time low against the Euro ($1.41). This is not only due to the rate cut, but also because Saudi Arabia is talking about dropping its peg to the dollar
. More strikingly, the Canadian dollar is now equal to the American dollar for the first time in over 30 years. Meanwhile, gold is at a 30 year high, and oil has set new record levels above $80 per barrel. $100 oil and $800 gold now look to be on the horizon.
It is unclear what all this means for the greater economy, but one thing is for sure: one should really try to avoid making predictions, especially about the future.
King dollar has lost his crown, and the implications of this move I think are clearly that inflation will again lift its ugly head.
What really bothers me is that the Fed is making moves to rescue the financial sector from a crisis that it created all by itself. There is no external factors involved, no emerging market crisis or major default. If an external crisis were to emerge now, there is little the Fed could do to prevent major fallout without jeopardizing the dollar and price stability drastically.
In fact, with this move the Fed has okayed the risk taking by the financial institutions and has sparked a new round of irrational exuberance. The correction will still have to come, and now we can be sure that when it does it will be even more painful than it has to be.Postscript:
Two "small" things I forgot to mention are as follows. Firstly, in all the confusion no one seemed to notice that the U.S. public debt surpassed $9 trillion. I don't remember Congress changing the law to allow for that, but oh well. Secondly, net purchases of U.S. bonds came in at under $20 billion in July down from just under $100 billion in June. With a current account deficit running at nearly $60 billion per month, this is not good.
And of course if you want the full story on the dollar, you really can't beat this post
. Be sure to scan the comments as well. Very enlightening.