Originally Posted by
Frasbee 
How does this shit affect me?
Ugh, where to start..
First, let me knock out the Forex issue out of the way..
For the moment, Core Inflation is increasing from 2%, to 2.5%, and expected to pass 3% in the next 5 years (that was already the case prior to January rate-cuts)
Basic principle in macroeconomics, when you increase the interest rate, you control inflation (this is why it's done during a boom, to prevent economic overheating which will lead to higher prices "inflation").. when you decrease the interest rate, you stimulate spending (you add more money into the economy, thus lowering the cost of money "interest" and you stimulate investment spending and consumption on durable goods; but by doing so, prices adjust "higher" even though output isn't really higher, and this results in inflation)
As far as Forex goes, for the moment, our inflation rate is relatively low (core inflation ignores the price changes of food & energy, these are highly volatile and core inflation aims to see meaningful trends uninhibited by short-run variations).. More US Dollars simply means that each one is worth less, and a higher price level and expected inflation (due to lower rates) will weaken the dollar even further.. What does it mean for you?
1. You can't go on vacation in Europe (boo-hoo).. which will keep spending local
2. Europeans love NYC & LA, because of a weak dollar, tourism is up, and tourism related revenue is increasing (leading to higher sales; which will act to stimulate the economy)
3. Aside from tourism, our net export defecit is closing, in the next 5 years, we're actually expected to have a surplus!
4. Thanks to China & India's growth, their price levels are actually increasing faster than our own, which causes our real Forex rates to favor trade towards us! Which means more imports from us, more sales (exports) for us, more money to firms and workers, more output, and more economic activity!
That's all nice and dandy, but we don't live in a Forex world..
If the interest rate is 3% and inflation is 2.5%, then the real interest rate is 0.5%; and in 5 years when inflation is at 3%, the real interest rates on federal funds will be 0%! (Obviously the fed can't sustain this policy for too long)
In fact, monetary policy can't help.. Not only are we facing low GDP growth (usually the Fed would cut rates to stimulate activity), but we also face increasing inflation (usually the Fed would increase rates to control inflation).. The Fed is left to pick the lesser of two evils (in this case, high inflation).. Monetary policy will increase Investment spending (relieve the housing crisis & renew investment in residential housing, lower the interest rates on Corporate Debt and stimulate business growth) & Consumption Spending (financial sectors will realize gains which will poor over to employees and spill over to other sectors of the economy, increase consumption of durable goods which are tied to long-term financing)..
This will have the effect of increasing GDP growth, but will also bring price levels higher (artificially) and increase inflation.. Fiscal Policy will also kick in (Government stimulus package), and pump $150 billion into the economy.. since the velocity of money is around (5), this will translate to $750 billion in economic activity (it really doesn't matter if it's a tax cut or government expenditure, in fact, it would be less effective if it was a tax cut "take my word on it, it's too technical/long to explain").. combine this with the Forex effect, and GDP growth will be back on track, helping us avoid a serious recession.. but at a cost (higher prices, inflation)
It will get interesting because after the 5 year mark, the Fed will have to adjust the rates, Inflation will be just over 3% so the rates will have to be at least that much, or else a negative real interest rate would mean the banks could borrow federal funds at a bargain! (they would make money borrowing money! it would be a negative real interest rate!) This would lead to extreame overheating and inflation; and we'd have the hyperinflation Germany faced during WWII where people would burn money because it was cheaper than buying wood or paper.. (Germany's WWII inflation rate was over 1,000% btw).. So GDP growth will have to be a priority and actually be fixed prior to the 5-year mark or else we'll really be in a tight spot! But GDP growth looks like it should improve well within those 5 years, so the Fed will be able to increase rates to control inflation & not hurt GDP afterwards..
The reason your Saving Acc. rate fell is simply because you have competition.. Imagine, the bank could borrow money from the Fed at 4.25% (but had to pay it over-night; that's the rate on over-night loans), OR it could borrow it from you at 5.05% (and take a whole year to pay you the interest).. Now the rate they have to pay on overnight loans is down to 3%, OR they can pay you 3.55% (over one year); honestly, they are getting a better deal if they borrow from you since the spread is smaller than it was before.. (you're obviously worse off, but there's nothing you can do about it, it's not your bank's fault) You should have purchased Bonds prior to January (stay away from them now, rates can only go up from here, which means bad news for bonds; inverse price relationship!)
If you want my opinion on where to invest your money:
- Merck (Drug companies such as Merck usually do well during economic downturns, plus a weak dollar adds to the 50+% of their total sales which are outside the U.S.)
- MSFT (Microsoft, in case you haven't heard, they're buying out Yahoo; which will place AOL under strain, and make Google look like a more attractive buy to the more qualitative investor; but quantitative analysis points to Microsoft's business diversity and focus on investing in growing sectors which will allow it to keep earnings per share strong in the 3rd & 4th quarters of this year)
- Financials (DO NOT go solo with I-Banks, instead invest in Mutual Funds which have a portfolio rich in Real-Estate Development, Banks, I-Banks, and Municipal Bonds "Munies".. they will hedge the risk for you, and are expected to return 4-8% per year "since the final rate cut")
- Buy Land (I have 1 acre in Florida in the middle of nowhere just north of Tampa; I got it 4 years ago for $4,000.. "I thought, for that money, and 1 acre, why not!", Since I have nothing but trees all over the property, I get a credit which reduces my annual taxes to just $157.. 3 months ago, the most recent appraisal valued it at $38,000.. hint, it's just outside Tampa, and I was just there, Tampa is booming, they're moving the US's 2nd largest port to Tampa to avoid Miami traffic, in just 8-10 years, you won't be able to touch property in Tampa, and obviously the values of property around it will shoot up to reflect this change; buy it and let it sit there; the rate of appreciation will more than justify locking in your funds to such a long-term investment)