Poor former Fed Chairman Alan Greenspan. He can’t get a break. First he was blamed for the housing bubble that burst, and then he was blamed for the credit bubble that burst. Now, he’s get the blame for higher oil prices.
In Greenspan’s all-out campaign to keep deflation away from the U.S. economy during his tenure as Fed chairman, he brought interest rates in the U.S. down close to a 50-year low. As a result consumers borrowed like never before, borrowing to buy high- ticket items such as automobiles and homes.
The problem was that people were buying stuff they didn’t need. Big SUVs that drank a lot of gas and bigger homes or even second and third homes many consumers could not afford were the popular flavor by 2004-2005.
As interest rates started going back up to cool the hot real estate market, investors starting getting rid of their excess autos and homes. The bubble burst and the auto manufacturers started reporting billion-dollar losses, the homebuilders got close to bankruptcy.
New Fed Chairman Ben Bernanke, seeing the housing slump was worse than the Fed had predicted, reduced interest rates aggressively again to help American consumers. The Federal Funds Rate now stands at two percent, the lowest level since November 2004.
Today’s most talked about economic problem is higher oil prices. As investors, we must understand that the price of oil for Americans is tied directly to the value of the U.S. dollar against other world currencies. And with our dollar now at the lowest level against the euro in a month, and close to the 10-year low it marked against the euro in late April, oil prices continue to remain high.
The Fed Open Market Committee meets this week to decide on interest rates. How can the Fed raise interest rates while the U.S. economy is so weak? Higher interest rates are coming, but they will take some time to get here. (Trading on interest rate futures points to the Fed maintaining interest rates at their current level when they meet this week.)
The Mexico peso is the strongest in five years against the U.S. dollar. And why would it not be with the bench market interest rate at 7.75% in Mexico? The Bank of Canada has pegged interest rates at 4.75% in Canada. In Australia, the central bank interest rate is at 7.25%. In New Zealand it is at 8.25%. And the European Central Bank is talking about raising interest rates from their current level of four percent.
U.S. interest rates are the lowest of the industrialized countries. That makes dollars less attractive than other world currencies. So, why would oil producers want to take U.S. dollars for their black gold? Until interest rates start to rise in America, high oil prices will persist and continue to be a problem for our economy. If only Greenspan had not brought interest rates so low in the first place, we would have been saved from a real estate bubble, a credit bubble and maybe even excessively high oil prices.