Kudlow, and a few others have chimed in on how having the fed ease would be good for the economy and the strength of the dollar. Since I thought that this is an interesting thought experiment and why not do some research.
The main crux of their argument is to look at the performance of the USD in terms of gold. Personally I think measuring against gold is bs, but hey that’s what they want to do! As outlined in my currencies blog entry it’s all relative.
Their argument is that by dropping interest rates the dollar will strengthen. I decided to be investigative and look at how the dollar has been doing throughout the years against four currencies; Canadian Dollar, German Mark, British Pound, and Japanese Yen.
Look at the following graph for the years 1956 to 1999. I chose 1999 because it was the last year of the Deutsch Mark.
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The interest rate is in the blue and the other lines are the currencies. Do you see a correlation between the interest rate and the currencies? Nope, I sure don’t. I even number crunched this a bit and could not come up with a correlation. I think these folks are correlating noise.
What bothered me about this is that the sample size is 50 entries and that is pretty darn small. Anything you say will be subject to wild confidence factor swings. So not being satisfied I decided to look even further back and at the website http://eh.net/ you can look at the exchange rates for the British Pound back back to 1791. Look closely at the following graph. It is how much a USD is worth with respect to a pound.
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The number 151 corresponds to the year 1936, and something very interesting should come to mind. At that time the gold standard was abandoned by most parties. So around 1930 an American would get 0.20 Pounds, and now an American would get 0.4972 Pounds. If this graph tells me anything is that the British should be crying on how weak their currency has become. The Brits should be chanting, “bring back the gold standard.” Yet is the American dollar that is benefiting from globalization. So my question then becomes, can you correlate the currencies, gold and interest? I think there is no real meaningful correlation!
With today’s action I have a certain theory. I have a theory that the market is playing chicken with the Central Banks of the world. They did earlier and the banks caved in. Now they are doing it by stocks and causing the market to go down. I have a theory that certain traders are again forcing the Fed to play a hand.
So here is a strategy on how to play the Fed rate debate. ONLY DO THIS IF YOU HAVE MONEY THAT YOU CAN GAMBLE AWAY. Get yourself a delta neutral buy straddle on one of the indices for October. I am guessing regardless of the decision there will be quite a bit of movement either way. If there is a cut it will be buying, if there is no cut then liquidation on a massive scale. If there is buying then I will not be buying since it will be a temporary thing. If there is a liquidation then I will be going long since it will be time to start buying shares.