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Wednesday, July 16, 2008

Does the Fed Get It?

That answer would be a resounding no if you asked Steve Forbes.

The Fed must act immediately to strengthen the dollar, says Steve Forbes, publisher of Forbes magazine.

"You cannot have a strong economy with a weak dollar," Forbes observes. "That's what the Fed doesn't get."

"Instead, the Fed and Treasury are saying, 'We've got to fight malaria, and then we'll deal with the mosquitoes.'"

Forbes continues his one man debate on the nature and purpose of Fed policy. Much of what he said today is an extension of ideas laid out in this piece...

Since World War II most countries have regarded monetary policy as a critical instrument (the other biggies being government spending and taxation) in regulating the economy. If economic activity is slowing, so the thinking has gone, the central bank should rev up the printing presses: The extra money will stimulate growth. Conversely, if the economy is growing too quickly, the central bank should tighten up on money creation, slowing things down to avoid the economy's careening off the road in the equivalent of a car wreck. The longest-serving Federal Reserve Chairman, William McChesney Martin Jr., liked to say that it was the Fed's job to take away the punch bowl just when the party really gets going.This is a misbegotten view of what central banking's main mission should be. The Federal Reserve should have two key tasks--and only two: preserving the integrity of the dollar and dealing vigorously with financial panics to limit unnecessary damage.


Greenspan's woes came about precisely because he lost sight of the Fed's prime job: ensuring a stable dollar. In the late 1990s Greenspan inadvertently tightened up. The most sensitive barometer of market mistakes is gold. During that time the yellow metal plunged to a low of $250 an ounce. Other commodities crashed, with oil dropping to nearly $10 a barrel. For a time the dollar became too dear, which contributed to the 2000--01 recession. When it became clear--just before George W. Bush was sworn in as President on Jan. 20, 2001--that the economy was skidding, Greenspan realized his mistake and started to reverse gears. But he stayed too easy, even when the economy was back on track. In 2004 gold began to surge well above its 12-year average, and oil began its long, rapid ascent, as did all other commodities. The dollar weakened not only against gold but also against other currencies, such as the yen, the Swiss franc and the pound. With money easy, the already buoyant U.S. housing market began to go berserk as lending standards started to decline precipitously.

Not coincidentally, Forbes' comments come on the same day as this troubling new report on inflation.

Consumer prices shot up in June at the second fastest pace in 26 years with two-thirds of the surge blamed on soaring energy prices.

The Labor Department reported that consumer prices jumped 1.1 percent last month, much worse than had been expected. Energy prices rocketed upward by 6.6
percent, reflecting big gains for gasoline, home heating oil and natural gas.

The big rise in prices cut deeply into consumers' earning power with average weekly wages, after adjusting for inflation, falling by 0.9 percent. It was the biggest monthly decline since a 1.1 percent drop in weekly wages in September 2005.

The 1.1 percent June price increase was the second largest monthly advance in the past 26 years, surpassed only by a 1.3 percent gain in September 2005 from a jolt to energy costs after Hurricane Katrina.

Forbes continues to be a lonely voice in daring to criticize the Fed in any manner. Most so called capitalists look to the Fed to take control of the entire market each and every time there is even a hint of trouble. Keep in mind, lawmakers are on the brink of expanding the Fed's regulatory power from oversights over banks to "financial services" institutions.

Forbes goes onto pin much of the blame of our ailing economy on the weak dollar. He even goes so far as to say that 80% of the increase in gas prices is due to the weak dollar. Whether or not Fed policy should be focused on a stable dollar as Forbes wants is still a matter of debate. There are several things that are NOT a matter of debate. There is no doubt that Fed policy contributed to weakening an already weak dollar. There is no doubt that the Fed knew this would happen and didn't care. There is no doubt this contributed to exploding gas and food prices. Furthermore, there is no doubt that Fed policy has been an unmitigated disaster since 1999. (the ten years previous to that were a period of excellent fed policy which is why his point is open for debate)

Furthermore, the Fed carries a very troubling combination. It is both incredibly powerful and misunderstood. If Forbes does nothing else, he is at least raising questions about the Fed. The worst thing happening right now is that the Fed is going through an enormous power grab. Yet, no one is daring the question the wisdom of this.

The Fed is held in extremely high esteem even though they have been nothing short of an unmitigated disaster for the last ten years. They raised rates starting in late 1999, which popped the internet bubble and lead to a recession. Next, they dropped the Fed Funds Rate below 1% and that got the ball rolling on the mortgage crisis. Finally, over the last few months they have furiously reduced rates and with it weakened the dollar which has created all sorts of new inflationary pressure. This is not the sort of performance that warrants more power and yet that's what most want to grant the Federal Reserve.

1 comment:

Anonymous said...

Yup ! We're screwed. Too late now.
The only fix is a reboot and hope it starts back up right. All I can say is, get ready...don't be fooled. Check this out.