The Real Reason Interest Rates Are Not Falling

Yesterday, it was reported that U.K. inflation jumped 3.1% in March, cementing an interest rate increase for the Bank of England next month. This is bad news for Americans who were hoping the Fed would cut interest rates in the U.S.

A country’s interest rate and the value of its currency are closely intertwined. Below is a list of the prime lending rates of industrialized countries:

U.S. 8.25% Australia 6.25% U.K. 5.25% Canada 6.00% Switzerland 4.08% European Community 3.75% Japan 1.88%

Scanning the above, you’ll quickly notice the U.S. has the highest prime lending rate in the industrialized world. Economics 101: One would think such high interest rates in the U.S. (compared to other industrialized countries) would result in the U.S. experiencing a relatively high currency value. But this is not the case.

As I noted Monday, the greenback is now at a two-year low against the euro. With its ever increasing debt, America needs foreigners to buy the bonds it issues to finance its debt. Foreigners, who have become such big buyers of U.S. bonds, aware of America’s debt, might be reluctant to buy bonds of a country whose currency is devaluing too rapidly.

Given that interest rates are high in the U.S. compared to the remainder of the world, if the U.S. cuts its interest rates, the greenback could plummet in value, causing problems attracting foreigners to buy our government issued bonds.

The real reason U.S. interest rates are not falling: Despite the help over-financed Americans would get if interest rates fell in the U.S., declining U.S. interest rates would plunge the value of the U.S. dollar on world markets. Ultimately, I believe a lower valued U.S. dollar would be good for the United States. But it needs to happen very slowly… and that means interest rates here in the U.S. may not fall as quickly as most expect.