Tuesday, September 18, 2007

Bernanke Gets It Right

Once in a while you get it right. One time in a row.

I talked about this in my last column, Goldilocks 2.0.

The Bernanke Fed made a good strong move this afternoon. The stock market applauded loudly with a 250-point rise in the Dow. Essentially, the Fed followed Treasury market rates lower. The 4 percent Treasury bill rate had been urging the Fed to make this move.

By itself, this action will not heal the credit markets overnight. But it will help. Lowering the cost of money will -- over time -- raise asset values across-the-board. New cash injections at the new target rate of 4.75 percent will raise the low 2 percent growth of the monetary base in order to accommodate the banking system’s unusually high cash demands.

Adjustable rate mortgage holders will get almost immediate relief.

This is a confidence-inspiring move by the Fed. Lenders will be more apt to lend and investors will be more apt to take risks.

Importantly, President Bush should now make it very clear that he will veto any tax hike proposals. With tax rates on capital remaining low, and a modest easing move by the Fed, the outlook for next year’s economy improves markedly.

We should see this first in the financial markets (like today’s stock rally) and then with a lag, we will see stronger economic activity.

I also suspect that over time, the improved economic growth outlook for the U.S. will actually strengthen the dollar’s exchange rate, in part because the interest tax on money has been lowered.

And while gold did rally immediately after the Fed move, I would look for some gold weakness along with a better dollar. In my view, rumors of stiff U.S. actions against Iran have been boosting oil and gold prices. Depending on world events, these two commodities are important barometers of political risk.

All that said, the Fed has followed the Treasury market message of lower rates. This is a very positive development that will strengthen the financial system and the economy.

Anchored by low tax rates, increasing economic growth will hold down inflation as stronger investment absorbs the Fed’s additional cash reserves.

They got this one right.