Thursday, December 18, 2008

"You Can't Hit Two Targets with One Arrow"

The above quote is by Dr. Robert Mundell, the 1999 winner of the Nobel Prize in Economics,who correctly forecast that breaking the dollar's link to gold would lead to a severely weakened currency, a corresponding rise in oil prices, and the ensuing inflation of the 1970's.

In this quote he was referring to the Fed Funds Rate and the value of the dollar. Mr. Bernanke thinks the focus should be on the overnight interest rate the Fed charges to member banks. Dr. Mundell thinks Bernake is wrong. Mundell correctly attributes the Feds misguided focus on setting interest rates, as opposed to a policy of maintaining a stable value for the dollar, as the cause of many of the financial problems past and present.

Had Chairman Bernanke and his predecessor, Alan Greenspan, focused on maintaining a stable value for the dollar, the see-saw monetary policy of the last decade would not have happened. There would not have been a tight monetary policy of the late 90's to deflate the dollar, crater commodity prices and end the decade by blowing up and finally collapsing the stock market in 2001. There would not have been a reversal to an overly accommodative monetary stance, which proved to be the precursor of the housing bubble and banking crisis. The chairman would not now be trying to once again inflate our way out of the falling home price debacle.

The Fed's policy blunder on top of policy blunder proves just how erratic this monetary operating mechanism really is, and reveals the plain truth. No one including Mr. Bernanke can run the economy by trying to guess what one interest rate, the Fed Funds Rate, should be set at several times a year.

The Fed needs to get it's focus back on the value of the dollar, People don't transact business in Fed funds rates, but rather they use the dollar. It is the dramatic change in the value of the dollar that is causing this financial chaos, and it's not just a problem in our country. The dollar's troubles are felt around the world. The dollar is the world's reserve currency, it's change in value impacts every transaction priced in dollars, and every transaction done in currencies linked to the dollar.

A weakening dollar will not attract the capital that the US needs for recovery, and the higher interest rates that it will ultimately usher in will be an anchor around the neck of this struggling economy.

A stable dollar, who's value can be counted on by investors, will draw capital to the US and which will provide the low interest rates that Bernanke is trying to artificially engineer with his mountain of liquidity. It will also stabilize commodity prices and and wrest the inflation genie back into it's bottle.

Einstein once said the definition of insanity is doing the same thing over and over again and expecting different results. Who am I to argue with him?

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