Stocks Close Lower Tuesday, Trade Gap Finally Narrows on Weak Dollar

After pulling up over the past week, stocks turned south again on Tuesday as investors began a profit-taking frenzy. The Dow Jones Industrial Average of 30 blue-chip equities lost almost exactly one percent of its value, and the broader Standard & Poor's Index of 500 large companies' stocks lost slightly more than a percent of its value. The NASDAQ composite index of smaller-cap companies' stocks lost eighty-five hundredths of a percent. Stocks were rallying early in the day, but a wave of selling in the afternoon turned the market decidedly sour. A rally later in the trading day stopped the free-fall, but it wasn't enough to make much of a dent in the overall negative numbers. Early Wednesday trading indicated that stocks were again under seige.

The bond market continued a troubling trend, with the benchmark 10-year long bond rising in price as investors pulling their money out of stocks loaded up on long-term debt issues. The price pressure upward caused the yield on the 10-year Treasury to drop to 4.20 percent. Early Wednesday trading indicated that the yield was continuing to ease, meaning that long-term debt instruments are coming that much closer to going below short-term yields, a phenomenon that almost always indicates a recession will occur within several quarters.

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The Federal Reserve affects short-term interest rates primarily by buying or selling short maturity government Treasury debt, which alters the prices, and therefore the yields, of that debt.

  While the Federal Reserve has been driving short-term interest rates upward in its fight against inflationary expectations building into the American economy, the market-driven long rates are not responding as the Fed would like. Although Fed Chairman Alan Greenspan has expressed his dismay with the situation regarding an impending inverted yield curve, he and his fellow Governors of the Federal Reserve have virtually no tools of monetary policy at their disposal to change the situation.

In other news Wednesday morning, the government reported that the trade deficit for April narrowed to $55 million dollars, a notable drop from the record $60.6 billion dollar red ink in March. The narrowing of the trade gap occurred mainly because consumers and businesses imported considerably less, even as the cost of petroleum was skyrocketing. The explanation for this is that the weakening U.S. dollar has had precisely the effect of pushing up the prices of all imports, energy and otherwise, and this has killed a significant amount of domestic interest in purchasing those imports. This scenario is partially confirmed by reports over the past few days that inventories of crude oil are rising, which would mean that, even though producers are still pulling the crude out of the ground at a relatively steady pace, the demand at the end of the line isn't drawing it to the refineries and then to the gas stations as quickly as it's coming into the inventories.

As far as the weakening dollar altering the relative balance of imports versus exports, not only were imports down in April, but exports were up, as well. This would indicate that the Bush Administration's strategy of publicly stating that it wants a strong dollar, while doing nothing to actually strengthen it, might be working to boost the American exports sector. Unfortunately, there are two downsides to this.

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Interest rates are the price of money. When domestic interest rates rise, the value of the U.S. currency does so, as well, thus making foreign imports cheaper and American exports more costly.

  The first is that the drop in purchases of imports is could be tied to slackening consumer demand for all goods and services because of an overall weakening of the U.S. economy. The other problem with this strategy is that, as the Federal Reserve continues its record string of short-term interest rate increases, the value of the dollar will strengthen, meaning that imports to the United States will become cheaper, once again, and American exports to other countries will become more expensive: these combined forces will cause the trade deficit to resume its upward climb, and the Bush Administration's hope that domestic exports will keep the U.S. economy from dropping into recession will be thwarted.