Interest rates have a direct impact on inflation, or the value of the dollar. When interest rates (the value that is charged to loan money) are low, inflation is higher because money is easy to loan and ultimately spend. Contrary to low interest rates, high interest rates cause consumers to save because loaning becomes more expensive.
The impact of high inflation is an increase in prices. This is not necessarily because companies want to earn more profit, it is mainly because the value of the dollar is less than when the dollar could buy more (low inflation). Since 1913, the value of the dollar has shrunk to 2 cents of its face value ($1), which means that your dollar could have bought 50 times more than what it can today.
The main argument with the stock market is whether or not interest rates and the money supply are one of the main indicators. While companies' stock prices are usually higher during inflationary periods, the money supply in the economy is largely credit, and therefore bubbles are created on loaned money that eventually will need to be paid back. I'll get into bubbles and how it inflates the stock market at a later point in my blog.
My second post will discuss exchange rates and their impact on the economy of the US. An exchange rate is the value of one currency against another (for example, the US Dollar against the Chinese yuan/renminbi). One of the main indicators of our economy's strength is our trade with foreign nations, more specifically China (as we are a major importer or Chinese goods). If the US dollar is inflated (buy less for more) and the Chinese currency is deflated (buy more for less), it means that the US has weaker purchasing power for Chinese exports, or in other words, Chinese exports become more expensive to buy because the dollar is less valuable in yuan/renminbi terms. Equally, American goods in China are more expensive because the US dollar is inflated, and ultimately, major US companies that export to markets like China (Microsoft, Intel, etc.) lose big time.
From 2001 to 2004, the US trade deficit with China doubled from roughly $80 billion to $164 billion. This was largely due to low interest rates during that period. The federal fund rate, or the rate at which the Federal Reserve loans money to banks, went from 6.24% in 2000 to 1.35% in 2004. This inflated the US dollar, making US goods more expensive, (in the US and around the world) as well as made Chinese goods more expensive to buy for American importers. This ultimately increased the budget deficit with China dramatically. Currently, the US has a trade deficit of about $227 billion with China. The US is currently trying to lower the trade deficit it has with China by pushing the Chinese government to deflate the price of the yuan. This would decrease the amount of imports the US receives from China, (US importers would buy less because it is more expensive) yet make US goods cheaper in China (US goods would sell more), ultimately lowering the trade deficit. An article on this issue can be found here.
During the beginning of the decade, the Chinese began buying US debt because the interest rates were low and it was attractive to borrow US money. This also stabilized the exchange rate of the US/yuan, because when the demand for US treasuries decreased via a massive purchase, interest rates remained low to avoid paying high yields. If you're confused on that part, just e-mail me and I'll be happy to elaborate. Onwards: In 2001, the Chinese owned $215 billion in US debt. When the US interest rates began their decline, the Chinese purchased enormous amounts of US debt (US Treasuries, or government bonds). In 2004, that amounted to a total of $609 billion. As we can see, when interest rates are lowered, money is cheaper to loan, and therefore, money is borrowed and invested.
Exchange rates are directly related to the interest rates of each country. Interest rates will value a currency, which then is revalued based on another currency. Most countries are dependent on trading with each other to ensure they meet the domestic demand. This has a direct impact on the cost of goods, and therefore, countries must strive to keep stable interest rates and monetary value to avoid extreme inflationary/deflationary periods.
This, or a lack of stability is what sparked the Great Recession of 2008. Our US dollar was inflated, the trade deficit seemed to be growing exponentially, and interest rates remained low. What triggered next was the banks borrowing massive quantities of money via the Federal Reserve's low interest rate, who then began lending to anyone and everyone. These lenders purchased homes largely on credit. Because interest rates were low, housing prices were rising (due to inflation, or goods becoming more expensive because the dollar buys less for more) and people saw this as a housing boom. In actuality, this was a massive housing bubble which was bound to collapse.
The impact of high inflation is an increase in prices. This is not necessarily because companies want to earn more profit, it is mainly because the value of the dollar is less than when the dollar could buy more (low inflation). Since 1913, the value of the dollar has shrunk to 2 cents of its face value ($1), which means that your dollar could have bought 50 times more than what it can today.
The main argument with the stock market is whether or not interest rates and the money supply are one of the main indicators. While companies' stock prices are usually higher during inflationary periods, the money supply in the economy is largely credit, and therefore bubbles are created on loaned money that eventually will need to be paid back. I'll get into bubbles and how it inflates the stock market at a later point in my blog.
My second post will discuss exchange rates and their impact on the economy of the US. An exchange rate is the value of one currency against another (for example, the US Dollar against the Chinese yuan/renminbi). One of the main indicators of our economy's strength is our trade with foreign nations, more specifically China (as we are a major importer or Chinese goods). If the US dollar is inflated (buy less for more) and the Chinese currency is deflated (buy more for less), it means that the US has weaker purchasing power for Chinese exports, or in other words, Chinese exports become more expensive to buy because the dollar is less valuable in yuan/renminbi terms. Equally, American goods in China are more expensive because the US dollar is inflated, and ultimately, major US companies that export to markets like China (Microsoft, Intel, etc.) lose big time.
From 2001 to 2004, the US trade deficit with China doubled from roughly $80 billion to $164 billion. This was largely due to low interest rates during that period. The federal fund rate, or the rate at which the Federal Reserve loans money to banks, went from 6.24% in 2000 to 1.35% in 2004. This inflated the US dollar, making US goods more expensive, (in the US and around the world) as well as made Chinese goods more expensive to buy for American importers. This ultimately increased the budget deficit with China dramatically. Currently, the US has a trade deficit of about $227 billion with China. The US is currently trying to lower the trade deficit it has with China by pushing the Chinese government to deflate the price of the yuan. This would decrease the amount of imports the US receives from China, (US importers would buy less because it is more expensive) yet make US goods cheaper in China (US goods would sell more), ultimately lowering the trade deficit. An article on this issue can be found here.
During the beginning of the decade, the Chinese began buying US debt because the interest rates were low and it was attractive to borrow US money. This also stabilized the exchange rate of the US/yuan, because when the demand for US treasuries decreased via a massive purchase, interest rates remained low to avoid paying high yields. If you're confused on that part, just e-mail me and I'll be happy to elaborate. Onwards: In 2001, the Chinese owned $215 billion in US debt. When the US interest rates began their decline, the Chinese purchased enormous amounts of US debt (US Treasuries, or government bonds). In 2004, that amounted to a total of $609 billion. As we can see, when interest rates are lowered, money is cheaper to loan, and therefore, money is borrowed and invested.
Exchange rates are directly related to the interest rates of each country. Interest rates will value a currency, which then is revalued based on another currency. Most countries are dependent on trading with each other to ensure they meet the domestic demand. This has a direct impact on the cost of goods, and therefore, countries must strive to keep stable interest rates and monetary value to avoid extreme inflationary/deflationary periods.
This, or a lack of stability is what sparked the Great Recession of 2008. Our US dollar was inflated, the trade deficit seemed to be growing exponentially, and interest rates remained low. What triggered next was the banks borrowing massive quantities of money via the Federal Reserve's low interest rate, who then began lending to anyone and everyone. These lenders purchased homes largely on credit. Because interest rates were low, housing prices were rising (due to inflation, or goods becoming more expensive because the dollar buys less for more) and people saw this as a housing boom. In actuality, this was a massive housing bubble which was bound to collapse.
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