The decision by the Federal Reserve to lower interest rates to 4.75% to pump liquidity into the credit markets may have a serious blowback effect as the US$ continues an accelerating decline in value.
And the Saudi government has announced it will not lower its interest rates to match the US decline, which in effect means it may be ending a decades-long policy of pegging the value of the Saudi Riyal to the US Dollar. and in turn could lead the Saudis and other holders of US-denominated securites to start selling their holdings to ensure higher returns on investment in other areas, such as the Eurozone.
The latest data from BBC :
US$1.00 = CAN$1.001
UK£1.00 = US$2.010
€1.00 = US$1.408
Needless to say, any US business involved in importing goods from overseas are seeing their profitability hurt. I know I am, as I own a small DJ-specialty record store whose business in 80% in records from the UK and the Eurozone. I've had to raise base prices twice in the past year, and still my profits are smaller than they were a year ago, even though in terms of business I've seen an increase in volume.
More worrisome though is the news reported in the Daily Telegraph and other sources that the Saudi government is not following the US in an interest rate cut, effectively depegging the Saudi Riyal from the US dollar that had been the traditional relationship for the last several decades.
As the article notes :
"This is a very dangerous situation for the dollar," said Hans Redeker, currency chief at BNP Paribas.
"Saudi Arabia has $800bn (£400bn) in their future generation fund, and the entire region has $3,500bn under management. They face an inflationary threat and do not want to import an interest rate policy set for the recessionary conditions in the United States," he said."
the article also notes
"The Fed's dramatic half point cut to 4.75pc yesterday has already caused a plunge in the world dollar index to a fifteen year low, touching with weakest level ever against the mighty euro at just under $1.40.
There is now a growing danger that global investors will start to shun the US bond markets. The latest US government data on foreign holdings released this week show a collapse in purchases of US bonds from $97bn to just $19bn in July, with outright net sales of US Treasuries.
The danger is that this could now accelerate as the yield gap between the United States and the rest of the world narrows rapidly, leaving America starved of foreign capital flows needed to cover its current account deficit - expected to reach $850bn this year, or 6.5pc of GDP."
So while many in the US hail the recent Fed decision as the way to ensure liquidity in the domestic US capital markets, the impact globally could very well produce a nasty economic shock as the ability of the US to sell its short term and long term debt.