Best of the Week
Most Popular
1. Stock Markets and the History Chart of the End of the World (With Presidential Cycles) - 28th Aug 20
2.Google, Apple, Amazon, Facebook... AI Tech Stocks Buying Levels and Valuations Q3 2020 - 31st Aug 20
3.The Inflation Mega-trend is Going Hyper! - 11th Sep 20
4.Is this the End of Capitalism? - 13th Sep 20
5.What's Driving Gold, Silver and What's Next? - 3rd Sep 20
6.QE4EVER! - 9th Sep 20
7.Gold Price Trend Forecast Analysis - Part1 - 7th Sep 20
8.The Fed May “Cause” The Next Stock Market Crash - 3rd Sep 20
9.Bitcoin Price Crash - You Will be Suprised What Happens Next - 7th Sep 20
10.NVIDIA Stock Price Soars on RTX 3000 Cornering the GPU Market for next 2 years! - 3rd Sep 20
Last 7 days
Gold Is the Winner of the U.S. Presidential Election - 31st Oct 20
Gold and Silver Prepare For Another Price Advance - 31st Oct 20
Gold Is Likely to Win This Election - 31st Oct 20
Why Trump Can Still Win 2020 Election - Establishment Mainstream Media Wrong Again? - 31st Oct 20
Why Budgies Need their Own Feeders - Parakeets Feeding UK - 31st Oct 20
Can Trump Still Win? US Presidential Election Forecast Matrix 2020 - 30th Oct 20
Why a Biden Win will Keep Metals Prices Rocking - 30th Oct 20
Is Silver the Next Bitcoin? - 30th Oct 20
A New World Monetary Order Is Coming - 30th Oct 20
Do These Explanations Make Sense for This Intraday Stock Market Turn - 30th Oct 20
US Presidential Election Forecast Matrix, Stock Market Uncertainty - 29th Oct 20
Stock Market Turning? Look For These Support Levels - 29th Oct 20
Silver: A Conceivable Dead-Cat-Bounce on the Cards - 29th Oct 20
Stocks are Strong but be Aware of this Continuing Pattern - 29th Oct 20
The Most Profitable Way To Play The Gold Boom - 29th Oct 20
Why You Should Hire An Accountant To Complete Your Tax Return - 29th Oct 20
Global Banking: Some Sectors Look as "Precarious as Ever" - 28th Oct 20
Silver Price Minor Dip Possible Before 2nd Major Upleg Starts - 28th Oct 20
�� How to Carve a Simple and Scary Pumpkin Face for Covid Halloween 2020 �� - 28th Oct 20
Gold Price One Last Dip Likely Then Major Upleg to New Highs - 28th Oct 20
Smart Money Is Going All-In On This New Gold Frontier - 28th Oct 20
Gold Stocks Still Correcting - 27th Oct 20
Gold and Crypto: Is This How Charts Look Before A Monetary Collapse? - 27th Oct 20
Silver's Coming Double Trigger Shotgun Price Explosion - 27th Oct 20
The $126 Billion Gold Opportunity in Australia - 27th Oct 20
Tips to Breeze through Your Spanish Classes Online - 27th Oct 20
Try The “Compounding Capital Gains” Strategy Today - 26th Oct 20
UK Coronavirus Broken Test and Trace System, 5 Days for Covid-19 Results! - 26th Oct 20
How the Coronavirus is Exacerbating Global Inequality, Hunger - 26th Oct 20
The Top Gold Stock for 2021 - 26th Oct 20
Corporate Earnings Season: Here's What Stock Investors Need to Know - 25th Oct 20
�� Halloween 2020 TESCO Supermarkes Shoppers Covid Panic Buying! �� - 25th Oct 20
Three Unstoppable Forces Set to Drive Silver Prices - 25th Oct 20
Car Insurance And Insurance Claims and Options - 25th Oct 20
Best Pressure Washer Review - Karcher K7 Full Control Unboxing - 25th Oct 20
Further Gold Price Pressure as the USDX Is About to Rally - 23rd Oct 20
Nasdaq Retests 11,735 Support - 23rd Oct 20
America’s Political and Financial Institutions Are Broken - 23rd Oct 20
Sayonara U.S.A. - 23rd Oct 20
Economic Contractions Overshadow ASEAN-6 Recovery - 23rd Oct 20
Doji Clusters Show Clear Support Ranges for Stock Market S&P500 Index - 23rd Oct 20
Silver Market - 22nd Oct 20
Goldman Sachs Likes Silver; Trump Wants Even More Stimulus - 22nd Oct 20
Hacking Wall Street to Close the Wealth Gap - 22nd Oct 20
Natural Gas/UNG Stepping GAP Patterns Suggest Pending Upside Breakout - 22nd Oct 20 -
NVIDIA CANCELS RTX 3070 16b RTX 3080 20gb GPU's Due to GDDR6X Memory Supply Issues - 22nd Oct 20
Zafira B Leaking Water Under Car - 22nd Oct 20
The Copper/Gold Ratio Would Change the Macro - 21st Oct 20
Are We Entering Stagflation That Will Boost Gold Price - 21st Oct 20
Crude Oil Price Stalls In Resistance Zone - 21st Oct 20
High-Profile Billionaire Gives Urgent Message to Stock Investors - 21st Oct 20
What's it Like to be a Budgie - Unique in a Cage 4K VR 360 - 21st Oct 20
Auto Trading: A Beginner Guide to Automation in Forex - 21st Oct 20
Gold Price Trend Forecast into 2021, Is Intel Dying?, Can Trump Win 2020? - 20th Oct 20
Gold Asks Where Is The Inflation - 20th Oct 20
Last Chance for this FREE Online Trading Course Worth $129 value - 20th Oct 20
More Short-term Stock Market Weakness Ahead - 20th Oct 20
Dell S3220DGF 32 Inch Curved Gaming Monitor Unboxing and Stand Assembly and Range of Movement - 20th Oct 20
Best Retail POS Software In Australia - 20th Oct 20
From Recession to an Ever-Deeper One - 19th Oct 20
Wales Closes Border With England, Stranded Motorists on Severn Bridge? Covid-19 Police Road Blocks - 19th Oct 20
Commodity Bull Market Cycle Starts with Euro and Dollar Trend Changes - 19th Oct 20
Stock Market Melt-Up Triggered a Short Squeeze In The NASDAQ and a Utilities Breakout - 19th Oct 20
Silver is Like Gold on Steroids - 19th Oct 20
Countdown to Election Mediocrity: Why Gold and Silver Can Protect Your Wealth - 19th Oct 20
“Hypergrowth” Is Spilling Into the Stock Market Like Never Before - 19th Oct 20
Is Oculus Quest 2 Good Upgrade for Samsung Gear VR Users? - 19th Oct 20
Low US Dollar Risky for Gold - 17th Oct 20
US 2020 Election: Are American's ready for Trump 2nd Term Twilight Zone Presidency? - 17th Oct 20
Custom Ryzen 5950x, 5900x, 5800x , RTX 3080, 3070 64gb DDR4 Gaming PC System Build Specs - 17th Oct 20
Gold Jumps above $1,900 Again - 16th Oct 20
US Economic Recovery Is in Need of Some Rescue - 16th Oct 20
Why You Should Focus on Growth Stocks Today - 16th Oct 20
Why Now is BEST Time to Upgrade Your PC System for Years - Ryzen 5000 CPUs, Nvidia RTX 3000 GPU's - 16th Oct 20
Beware of Trump’s October (November?) Election Surprise - 15th Oct 20
Stock Market SPY Retesting Critical Resistance From Fibonacci Price Amplitude Arc - 15th Oct 20
Fed Chairman Begs Congress to Stimulate Beleaguered US Economy - 15th Oct 20
Is Gold Market Going Back Into the 1970s? - 15th Oct 20
Things you Should know before Trade Cryptos - 15th Oct 20
Gold and Silver Price Ready For Another Rally Attempt - 14th Oct 20
Do Low Interest Rates Mean Higher Stocks? Not so Fast… - 14th Oct 20
US Debt Is Going Up but Leaving GDP Behind - 14th Oct 20
Dell S3220DGF 31.5 Inch VA Gaming Monitor Amazon Prime Day Bargain Price! But WIll it Get Delivered? - 14th Oct 20
Karcher K7 Pressure Washer Amazon Prime Day Bargain 51% Discount! - 14th Oct 20
Top Strategies Day Traders Adopt - 14th Oct 20

Market Oracle FREE Newsletter

How to Get Rich Investing in Stocks by Riding the Electron Wave

Why US Interest Rate Cuts if GDP is Growing by 5%?

Economics / US Interest Rates Dec 09, 2007 - 01:00 AM GMT

By: Andy_Sutton

Economics Overall, the Federal Reserve must be given decent marks for keeping up appearances in the wake of the onset of the largest credit crisis in US history. For the situation is now ubiquitous, wreaking havoc in virtually every market. True to form, the Fed has continued to modify its statements, perceptions all in an attempt to manage the public's confidence in the fact that yes, they are still in control of the economy. There have been, however, an increasing number of discrepancies and important issues emerging over the past several weeks and some startling but expected developments.

GDP near 5% along with rate cuts

US GDP was recently reported to be growing at an annual rate of 5% in the third quarter of 2007. From a historical perspective, 5% is a pretty good growth rate, and indicative of a healthy economic expansion. The prudent question to ask then is why has the Fed already cut interest rates 75 basis points in the second half of the year with another 25 likely next Tuesday? Why has the discount rate been cut so aggressively? Why have massive injections of additional money into the banking system been necessary? While the former would indicate stable growth and prosperity, the latter is indicative of a massive resuscitation effort. Upon observation, the GDP numbers simply don't add up. Consumer spending (which accounts for around 70% of GDP) has been flat. Exports have risen in the environment of the falling dollar, but not at a 5% rate. Imports have been fairly steady as well. 

So where is the 5% figure coming from? Before the final GDP number is released, the nominal figure is ‘deflated' by the GDP price index. For example, let's say consumer prices rose at a 5% clip annualized during the third quarter and the nominal (unadjusted) GDP was 6%. In this case the real GDP growth would be 1%. The GDP deflator used during the third quarter was stated as .9%. While it is certainly open to debate as to the authenticity of the deflator, the mechanism for releasing ‘friendly' or ‘situation-specific' numbers can be observed rather easily. A deeper question would be if it is possible or likely to have a robust economy coexist with a massive credit crunch, particularly when the bulk of that credit crunch surrounds the source of much of the recent growth?

Bailout plan for distressed homeowners announced

The only surprise here is that the proposed bailout did not come sooner. The President today unveiled an agreement to freeze rates on some subprime loans, stating now that the fallout is a ‘source of concern'. The three options as outlined will be to freeze rates, allow refinancing into a fixed rate new private mortgage or a FHA-backed mortgage. This measure was supposedly adopted not only to protect the homeowners from foreclosure, but also to protect the value of the securities that these distressed mortgages back. The problem is a simple one: The mortgage bonds strewn around the world were constructed with the assumption that the rates on the underlying mortgages would increase. The prices paid for these bonds were predicated on that assumption. When this proves not to be the case, the value of the mortgage bonds is sure to fall, albeit to a lesser extent than if the mortgages were to default. 

It is obvious that the government is doing whatever possible to protect the consumers' ability to spend. However, this bailout does nothing to address the rising inventories of homes, falling prices, and an estimated 600,000 homeowners who will not qualify for assistance. Moreover, forcing institutions to take on additional credit risk in the form of guaranteed loans for otherwise unqualified applicants will only pile additional risk onto an already distressed market.

In my view, we should not be assisting anyone. Adults made conscious choices. “I didn't know” is not an excuse. Our economy desperately needs cleansing. The rapidly increasing foreclosures, while causing pain, would have aided in the cleansing process. Government is now intervening to prevent this pain from taking place. This will pave the way for increased credit expansion, more inflation and more stress for consumers; even those who have been diligent about their financial decisions.

Canada, England, Middle East line up to support the faltering dollar

This week the both the Bank of Canada and the Bank of England reduced rates. In Canada, the benchmark rate was cut 25 basis points to 4.25%. England also reduced the benchmark rate by 25bp to 5.75%. The rationale behind the move was that inflation in Canada wasn't growing fast enough. The Canadian people should be thankful that their banking officials are so vigilant in protecting them from the awful consequences of deflation (sarcasm mine). The Bank of England tossed aside inflation concerns in favor of protecting economic growth in the midst of increasing costs of credit and falling home prices. 

The Middle East also decided earlier this week to maintain currency pegs in support of the dollar. Interpreted, this means that they will devalue and inflate their currencies for the purposes of supporting ours. While some would view these developments as positive for the dollar, I view them as negative for savers the world around. Unfortunately, this race to the bottom will make it harder for investors in the United States to find meaningful proxies by which to compensate their portfolios for the dollar's loss of purchasing power.

Contrary to the popular belief on Wall Street and in Washington that the credit fiasco is contained and under control, the situation is anything but. Bailout plans for banks, hedge funds, and now individual homeowners should underscore the breadth of this crisis despite the illusion that this whole mess is nothing but a small roadblock. The tools at the disposal of government for dealing with such a crisis are few given that economic pain is not acceptable in today's society. As prudent investors we must realize that these tools will be used and more importantly, how to protect our wealth in this environment.

In next week's piece, I am anticipating doing another cooperative piece with Atash Hagmahani relating to how valid investment opportunities are being removed from the table for average retail investors and how risk-reward dynamics have undergone a severe adjustment in recent months.

By Andy Sutton

Andy Sutton holds a MBA with Honors in Economics from Moravian College and is a member of Omicron Delta Epsilon International Honor Society in Economics. He currently provides financial planning services to a growing book of clients using a conservative approach aimed at accumulating high quality, income producing assets while providing protection against a falling dollar.

Andy Sutton Archive

© 2005-2019 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.

Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules