Monday, September 17, 2007

FOMC rate decision, Tuesday 2:15pm (Eastern)

I'll see you all on the other side.

I think the best thing for Bernanke to do here is increase the rate by 25bps. When enough time passes, I suspect more people will agree with me. Inflation still looks like the greater threat.

Until August, it was a foregone conclusion that the target rate would remain above 5%. Shows what a lot of angst in the market can do. But like this piece says, I also think that the Fed needs to look in the mirror to see the biggest contributor to this current circumstance:

With that in mind, it's hardly reassuring that both Messrs. Bernanke and Greenspan are now offering their own defenses of Fed policy. They take different forms, but they are both in essence alibis for the Fed's current predicament.

Mr. Bernanke made his attempt in a speech last week on the "global savings glut," which seems to be his full-field explanation for just about everything. The rise of excess savings in China, the Mideast and elsewhere in the early part of this decade made them net exporters of capital, which proceeded to flow into the U.S. The Fed chief argues that this propelled the U.S. current account deficit and also explains why American long-term interest rates have stayed so low. Translation: The Fed didn't cause the housing bubble; frugal foreigners did it!

As an oil importer, China is a little different case. But as Mr. Bernanke noted in his speech, "with consumer credit not readily available and precautionary motives for saving remaining strong," China's domestic consumption was also restrained. So its capital also flowed abroad -- again often into U.S. financial instruments. Mr. Bernanke is right about these flows of capital and their contribution to low U.S. interest rates, but he's more than a bit slippery in ignoring the Fed's role in this global wealth transfer.

Meanwhile, Mr. Greenspan has emerged from the six-figure speaking circuit with his memoir, "The Age of Turbulence." The headlines are focusing on his criticism of Republicans for their spending excesses, and President Bush for his failure to use his veto pen. He'll get no argument from us on those, though we'd note that his claim that deficits produce higher interest rates simply hasn't proved true.

The "Maestro" is far less persuasive in his explanation for why the Fed kept money so easy for so long. He says it was to "shut down the possibility of corrosive deflation." But fear of deflation was long gone by the third quarter of 2003, after the second round of Bush tax cuts had passed and GDP growth clocked in at 7.2% on an annual basis (later revised to 7.5%). The Fed nonetheless maintained negative real interest rates for many more months to come. This has proven to be the great policy blunder of Mr. Greenspan's tenure, with ramifications that are making life difficult for Mr. Bernanke today.

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