Thursday, May 1, 2008

When the Dollar Makes No Sense

The Fed lowered short term interest rates once again in a move that will be celebrated by the media. Unfortunately it will continue to weaken the dollar and drive commodity prices including, yes, oil, up ever farther.

Many believe the Fed should show more restraint. Modern Americans however seem to expect the Fed to not only bring the economy in for a soft landing when it trends towards recession, but to actually head one off.

But if we are to experience a recession, wouldn't it be best if we just got it over with? What happens if the Fed keeps pulling it's lever and it loses it's effect? What then?

An unstable and devalued dollar will continue to wreak havoc on our economy if for no other reason, the high cost of energy as more and more dollars are needed to buy it.

Changing our fiscal (spending) policy will soon be our only option to restore value to our dollar and stabilize our economy. Think of monetary (interest rate) policy as cotton candy. It's a quick shot of energy but then you're even more hungry than you were.

Fiscal policy is more like a well-rounded meal, and that's what we need now. Conservative fiscal policy, something we have not seen in many years.

Why would the Fed base policy on a trade-off which does not hold beyond the short run, and is the underlying premise of the stop-go monetary strategies that have caused boom-and-bust instability?

...exploding fiscal deficits, the housing correction, protectionist threats and $200 billion in tax hikes scheduled for 2011 are fueling loss of confidence in the U.S. dollar. If foreign holders of dollars or dollar-denominated assets sell them, all the good effects of being the de facto international reserve currency start operating in reverse. Until fiscal and monetary policies change, all this implies future inflation and higher interest rates.

The bottom line is this: the Fed should...cease attempts to fine-tune perfect balance between inflation and recession. It should halt further rate cuts and soon begin a series of interest rate increases.

...economic growth and low inflation are not a mutually exclusive trade-off.

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