The Downsides of the Lower Interest Rate

Sep 23, 2007 by Adam C. Powell, Ph.D.

Ben Bernanke lowered the rate by 0.50% last week. It’s been great to see my stock portfolio substantially recover as a result. By lowering the rate, Bernanke reduced the cost of credit. But, I’m not entirely happy about the move. What are the downsides to the lower interest rate?

 As I have mentioned in the past, I keep some of my money in a savings account at eLoan. Last month, I was receiving 5.25% APY, and now I am only receiving 5.00% APY. As the cost of credit has decreased, the bank is now willing to pay me less for my money. Likewise, the returns on certificates of deposit (CDs) have been decreased as well. For those that bought six-month CDs last month, you have locked-in whatever rate you got for the next six months. New CDs being originated after the change will be affected by the change.

Those traveling abroad will also be disappointed by the reduction in the interest rate. While the dollar was already weak, the reduction further eroded its value. For the first time since 1976, the Canadian Dollar is equal in value to the United States Dollar. (Many Americans may have in the past been accustomed to seeing magazines marked with prices denominated in both U.S. and Canadian dollars, with the Canadian price being about $1 higher.) As a result of the weakening of the dollar, less goods can be purchased for $1 USD. In Canada for example, most goods probably cost about what they did last month. However, since $1,000 US now buys fewer Canadian Dollars than it did last month, someone buying goods from Canada would effectively be less wealthy. This principle holds with respect to our trade with other nations as well. Thus, merchandise in China and the European Union is now also more expensive for Americans.

 How can someone combat a weakening dollar? Buy assets that are denominated in foreign currencies. For instance, if you had some of your money in Canadian Dollars before the rate change, you would have instantly made a profit as a result of the change, if you re-measured your assets in United States Dollars. One way that I fight the weakening dollar is by investing in foreign companies. When the dollar gets weaker, the companies simply become worth more dollars, as their values are based on foreign currencies in the first place. Thus, the weakening dollar may be a further reason to invest in foreign exchange traded funds (ETFs).