Monday, April 28, 2008

The Fed Needs to Stop

The Fed needs to stop cutting interest rates and halt the run on the dollar. They can do this by announcing a lengthy pause in their interest rate statement due out this Wednesday at 2:15 pm.

Over the past month or so, gold has dropped, and the dollar has stabilized. This is because investors sense that the Fed is finally coming to the end of their rate cutting. Another quarter-point cut later this week would be a bad idea.

Gold, oil, and food commodity prices have all exploded in recent months as the Fed has over-stimulated its easing polices. The real fed funds rate remains negative. And in a market-based bond model, the negative real fed funds rate remains far below the economy’s so–called natural rate. It’s the lowest since the spring of 2005. It’s no wonder there’s been a big run against the greenback.

Voters are irate over the higher cost for gas and food. Truck drivers are preparing to march on Washington, D.C. in a strike against soaring prices for diesel fuel. Meanwhile, politicians on both sides of the aisle are making goofy policy proposals like instituting a windfall profits tax (Hill-Bama) or declaring a summer gas tax holiday (McCain). Yes, of course we need a good energy policy with a broad portfolio of all energy sources. No question about it. But let’s be very clear: the Federal Reserve has played a lead role in creating this energy and food price debacle.

As one of the financial news services put it today, Fed chair Ben Bernanke needs to act more like his hard money predecessor Paul Volcker, in order to avoid becoming stagflationist Arthur Burns.

It’s time to stop.