The recent cut in the benchmark interest rates by the US Federal Reserve by 75 basis points from 4.25 per cent to 3.50
per cent on January 22 and a further 50 basis points to 3 per cent on January 30 as a response to a possible recession in
the United States has completely surprised analysts across the world.
Unprecedented as it is, this steep cut in the interest rates effected by the Fed has the potential to dynamite the US dollar,
the US economy and, by extension, the global economy.
What could surprise many is the fact that the US Fed's prescription to reduce interest rates, ostensibly to tackle the
prospect of a recession might well turn out to be its Waterloo. Put bluntly, the US faces as much of a risk of a recession
after this rate cut as it did before.
Two economists end up usually giving rise to three opinions. Nevertheless, most of them are near unanimous in their view
that the situation in the US economy is quite serious. In fact, many experts are veering to the view that the US economy --
the engine of the world economic growth -- is well and truly into recession.
What is increasingly viewed as conclusive proof of a recession within the US is that the US Fed cut interest rates on three
occasions in the second half of 2007 aggregating to 100 basis points, prior to this cut of 125 basis points in January 2008.
All these are alarming signs indeed.
Breather for (sub-prime) borrowers?
Ostensibly this cut is aimed at alleviating the worst housing recession in the US since 1991 and ease the pressure on the
economy. The situation is so appalling that some US lawmakers had even called for cheaper borrowing costs for the
benefit of the average Americans (and you thought that such silly demands could be made only by our desi politicians).
And this cut is aimed at providing succour to all those stakeholders -- borrowers and lenders -- who were party to this
credit extravaganza for the past several years. It may be noted that it is this credit expansion in the US that acted as a defacto
compressor for the above mentioned engine of global economic growth.
And it is not a problem that pertains only to sub-prime borrowers, as is commonly believed. As many credit card, car and
consumer loans too are beginning to turn bad, the US financial sector is facing a crisis of an unprecedented magnitude.
Consequently, with many banks and financial institutions facing prospects of going belly up, the Fed had no other option
but to cut interest rates. For, if it hadn't effected a rate-cut, it would have triggered a severe crisis within the US financial
sector over the next few months and might have led to the collapse of many financial institutions.
But will it solve the problem?
Apparently, by cutting interest rates the US Fed expects to stimulate consumption, crucially lower mortgage payments, and
in the process trigger a recovery in the US economy. Be that as it may, top economists -- including Noble Laureate Joseph
Stiglitz -- point out to the futility of this exercise saying that this cut in interest rates will have little impact on the overall
According to them, it is a case of too little and too late -- akin to applying pain balm when chemotherapy was the need of
Even as the interest rate cuts are carried out experts believe that US Fed chairman Ben Bernanke may be open to the
charge of creating 'moral hazard.' After all, in sum and substance, the act of the Fed is rewarding all those who were party
to reckless borrowings and lending.
As US lowers its interest rates dramatically, economists are worried that it could find that global capital is moving away to
other countries which offer higher rates of interest simply on account of arbitrage opportunities. This could mean
appreciation of currencies across continents and depreciation of the US dollar. As the dollar depreciates against other
currencies, goods from other countries would become costlier in the US, leading to inflationary pressures within the US
According Allan Meltzer, a Fed historian, the Fed "put all of its chips on the prospect of a possible recession, and very little
on the possibility of inflation." And should the US be visited by a bout of inflation, as predicted, the Fed would have no
other option but to once again increase interest rates. And that could be an unmitigated disaster.
What could worry the US economists is that years of sustained imports of 'cheap' goods -- ostensibly aimed at controlling
domestic inflation -- meant ignoring the competitiveness of the domestic manufacturing sector in the US. It may be noted
that this model also suited developing nations as it provided cheap manufactured products to them, made cheaper through
a strong dollar. But all good times have to come to end, right?
American economist Robert Blecker has examined the impact of the extant currency valuation arrangement between the
US and other currencies on the US manufacturing investment spending. He estimates that under this paradigm the US
manufacturing investment was lowered by 61 per cent between 1995 and 2004. This has structurally and systematically
weakened the US industrial base making imports inevitable to meet the gargantuan domestic consumption.
Further, it also makes the future task of developing a competitive domestic manufacturing base within the US in the next
few years an exercise in futility. Given a weak-manufacturing base in the US and the extent of dependency on imports to
meet domestic demand, it is quite probable that any further depreciation of the dollar could stoke inflation in the US. And
that could be a trigger for higher interest rates.
But will it lead to a collapse of the dollar?
But inflation within the US is not the only issue that bothers economists. What complicates the entire matrix is that the US
is dependent on global capital flows of approximately $900 billion in 2007 to sustain its economy. With global inflation
untamed and central bankers of other countries having virtually exhausted every other policy option to deal with inflation,
interest rates are at a high across continents.
Naturally, none of the central bankers of other economies are in any mood to cut interest rates in tandem with the Fed.
Consequently, it is feared by many economists that this steep interest rate cut effected by the Fed would trigger currency
readjustments. This would be particularly sharp should different economies fail to lower their domestic interest rates.
It is thus no wonder that the dollar is going the Titanic way against the other currencies even as I write this. Similarly, given
this paradigm of interest rate differential prevailing between the US and India, the Rupee which had posted handsome
gains against the dollar in recent months too is expected to appreciate further in coming months.
Naturally, the Reserve Bank of India is caught in this predicament. As global capital finds its way to India because of
higher interest rates here, RBI would increasingly be 'forced' to cut interest rates. If it does not, the deluge of foreign
exchange flows would lead to a corresponding increase in Rupee circulation within the economy and thereby lead to
higher inflation and still higher interest rates.
But with an overhang of liquidity and domestic inflationary pressures caused due to a multiplicity of local factors, lowering
interest rates is not a preferred policy option. No wonder the RBI was reluctant to cut interest rates while undertaking the
latest review of the Credit Policy on January 29. Surely, a Catch-22 situation for RBI.
Given this scenario, as (stock) markets realise these intrinsic dangers arising out of interest rate cuts initiated by the US
Fed, they are sure to witness some correction.
No wonder markets the world over are already feeling exhausted within days of the Fed announcing the moves. Where is
the question of comparing or analysing the quantum of risks, returns and rewards when the principle itself is in doubt? This
is one question that seems to have come back to haunt market players as they understand the mess in all its dimensions.
For all these reasons the interest rate cuts may not work and Fed's game plan could well be condemned. And that is the
crux of the issue -- the US economy would have collapsed had the Fed not cut the interest rates and as it cuts the interest
rates it could endanger the dollar and cause its collapse.
Needless to emphasise, the beneficiary of the rate cuts are the stock markets and not the US economy as a whole as is
So what was the compulsion for the Federal Reserve to take this gamble? Why protecting the US stock markets became
more important that anything else for the Fed Reserve? Is the US stock market more precious than the US dollar? Is
bailing out the reckless lenders and borrowers more important than controlling inflation in US?
Questions that are too crucial and the answers to these questions may well determine the fate of the global economy in
the next few moths.
Central bankers, economists and analysts are an anxious lot. As stock markets across continents are inexorably linked
to the US Fed, they realise that the move to cut interest rates has far reaching implications. They know for sure that to
save the United States' financial sector as a whole from complete collapse, the Fed has taken a huge gamble, especially
on the dollar.
This could, in turn, have a debilitating impact on the US financial sector, American economy and by extension on the
global economy, as talked about in the previous part of this column.
But as global markets debate the rate cut move, the US Fed -- the author of the move itself -- goes virtually un-scrutinised
and unquestioned, in and outside the US. Crucially, the approach of the Fed to savings, investments, stock markets and
the symbiotic link provided to all these is central to understanding its motives and what drives its decisions.
Interest rate cuts -- Who benefits?
Despite being dependent on other countries for funding its trade deficit, the US establishment has never been bothered
about domestic savings. It is in this connection that Ben Bernanke, who was the head of George Bush's Council of
Economic Advisers and subsequently became the Fed chief, had suggested in 2005 that the world suffers from excessive
savings -- what he termed as 'savings glut,' implying lack of investment opportunities within developing countries.
Further, he argued that people save less in developed countries, especially in the Anglo Saxon ones, because of the
sophistication in their financial markets -- read investments in stock markets -- and that higher savings in other countries is
because of the 'poor returns' and 'underdeveloped markets.'
And Bernanke is not alone in this matter. In fact, this is the thinking within the Fed. . . Bernanke's predecessor, Alan
Greenspan, a celebrated economist and a Fed chief for over 18 years between 1987 and 2005 in his book The Age of
Turbulence, goes a step further and theorises that the propensity of the people to save is a sign of underdevelopment.
In contrast, he points out how developed countries, through their vast financial networks, enable a 'significant fraction of
the consumers to spend beyond their current incomes.' In short, according to Greenspan, Bernanke and the Fed, savings
is a sin, spending a virtue.
This paradigm was captured brilliantly by The Economist which in a paper published on April 7, 2005, points out: 'It may be
a virtue, but in much of the rich world thrift has become unfashionable. Household saving rates in many OECD
(Organisation for Economic Co-operation and Development) countries have fallen sharply in recent years. Anglo-Saxon
countries -- America, Canada, Britain, Australia and New Zealand --have the lowest rates of household savings.
Americans, on average, save less than 1 per cent of their after-tax income today, compared with 7 per cent in the
beginning of the 1990s. In Australia and New Zealand, personal saving rates are negative as people borrow to consume
more than they earn.'
All these are not as simple as it seems on superficial examination -- an issue related to the importance of savings in an
economy. What is crucial to remember is that if the developing ones do not fund the developed ones, especially the Anglo-
Saxon countries, for the requirement of their capital, these 'developed' countries could come to a grinding halt. This is one
issue that Alan Greenspan failed to answer in his book.
Naturally, as savings are scarce and remain only in the hands of the developing countries, it is in the strategic interest of
the developed countries to pay lower rate of interest for such 'import of capital.' And contrary to popular belief, it is this
export of capital from the developing country that is sustaining the developed ones, not the other way around.
But that is not the end of the matter. Crucially, by lowering interest rates, Ben Bernanke and his predecessor at the Fed
have been batting openly for the routing of the capital from developing to the developed countries and from investments
bearing fixed rates of interest to the stock markets, not only within the US but also outside.
With substantial US investments in global corporates and in stock markets across the globe, a cut in interest rates is in the
interest of US economy and also American corporates.
Move savings into the hands of the corporates
To understand the above a return to the textbooks is necessary. Fundamental economics tells us that interest rate cut
leads to two consequences.
First, it acts as a disincentive to savings and it simultaneously encourages spending. The second consequence is far more
complex. It moves money from the hands of individuals to the corporates through two routes: one, as stated above, it
encourages spending in the hands of individuals -- which means more income to corporates; and, two, it acts as an
dampener for interest-related savings, but encourages investments into stock markets.
I term this as the double-dose booster plan by the Fed for the markets.
Naturally, as individuals are prevented from saving in interest-related investments, viz. banks, and are simultaneously
encouraged to spend, interest rate cuts effectively are a double-dose booster for stock markets. No wonder, as interest
rates are cut by the US Fed, corporates and by extension stock markets across the globe are jubilant.
After all it must be the biggest subsidy, albeit implicitly, provided by the State to the (stock) markets and by the developing
countries to the developed ones!
The calculated effort of the US Federal system to shift savings from the households to the corporates, not only within the
US but also outside the US, as briefly explained above is central to the approach of Fed. And that would explain the logic
propounded by the Fed.
In fact, it would seem that the Fed is wedded to cause of the American corporates rather than American citizens. And in
this process anyone or any institution (including the institution of family which by its very structure encourages savings)
has to be de-legitimised, de-recognised, even destroyed. And it shall be done systematically by the powers that be.
The net result: America's savings rate has fallen to historic lows as mentioned above to less than 1 per cent. It does not
require an economist to state who is the net beneficiary of all this.
But who controls the Fed?
Before one proceeds to critically analyse the Fed, it is important to note its significance. It is in effect the central bank of
the world. Naturally, it needs to be put under maximum global scrutiny. Despite such overwhelming requirement there is an
important difference between the Fed and the other central banks. If most of the central banks are state owned or
government controlled, the Fed is an exception to this fundamental rule.
Readers may be surprised to note that the US Fed system is neither controlled by the US government nor is it a private
body, subject to oversight by a Regulator. Rather, as some analyst put it so succinctly, it is a cartel of private banks. And it
is structured in such a manner that its functioning is absolutely independent and secret -- even the US President or the US
Congress cannot interfere in its working.
Now the crucial question: who owns or controls these private banks that, in turn, control the US Federal system? Different
studies, conducted at various periods of time, have repeatedly pointed out that the owners of these banks include some of
the best and well-known global financial giants controlled by a few families.
Since these are private banks, ownership details are not disclosed to the public, there is considerable speculation about
the ownership of Fed. This is part of historical arrangement within the US.
But why should these private bankers be interested in controlling an interest rate regime? The final piece in this global
jigsaw puzzle: Approximately 75 per cent of the shares (another 10-15 per cent are with the pension funds) of Fortune 500
companies are with these investment bankers, who in turn own/control the Fed. No wonder, the Wall Street is interested in
the Fed and the Fed is interested in Wall Street. It does take two to tango.
Good luck to the dollar
Needless to reiterate, it is in the interest of these investment bankers to ensure lower interest rates to profit from the
double-dose booster plan as explained above. In other countries that would go in the name of lobbying. In the US it
becomes highly sophisticated.
Where is the question of lobbying when you have enslaved the regulator itself? And that explains the fixation of the US
Fed with lower interest rates, stock markets and rewarding reckless borrowers and lenders even at the cost of
endangering the dollar.
The first indicator that the US dollar is going to have a torrid future is borne out of the fact that ever since the Fed
announced the cut in interest rates the value of gold has shot through the roof and hit the all time high of $925 per troy
ounce (even as I write this).
Naturally, other commodities, viz. silver, crude oil, uranium, palladium, copper, tin, et cetera, will follow the pattern of gold
in the coming days.
And when prices of commodities go up, the net beneficiary would once again be American corporates who, anticipating
these developments, would already have built up significant positions on these commodities or planned some other
In the process if the dollar is affected, who cares? Not the Fed, definitely. After all it is a creation of the Wall Street, by the
Wall Street, for the Wall Street.
For a variety of reasons it would seem that endangering the dollar is in the interest of the Wall Street at this point in time.
The Fed has merely obeyed its masters at Wall Street. Good luck to the US dollar!
The author is a Chennai-based chartered accountant. He can be contacted at email@example.com