Money

As the whole world expected, the Fed raised its policy target rate by one-quarter of a percent to 2 percent. Since last June the fed funds rate has doubled from 1 percent to 2 percent. What is so interesting about this is that long term Treasury bond rates have actually fallen to around 4.25 percent from 4.75 percent. This is significant evidence that neither actual inflation nor expected future inflation is really a problem.

The Fed was right to move today but not for the reasons given by a majority of demand-side economists. It’s not about budget deficits, or trade deficits, or jobs growth, or what looks to be a strengthening economic recovery rate. The best reason for the Fed move is because short term interest rates have been rising -- the three-month Treasury bill had leap-frogged the old 1.75 percent Fed target rate and landed at nearly 2.10 percent.

The Fed is right to follow market interest rates, especially its unregulated T-bill cousin. Would that the central market would decontrol its own overnight target rate; then market forces would run monetary policy rather than econometric models that abide by discredited trade-offs between inflation and unemployment. Also in the realm of market forces, the dollar lately has lost some additional value in terms of gold and foreign currencies. So there could be a small amount of excess money which needs to be absorbed by the government bank. When they raise their target to 2.25 percent next month it is quite possible that they will have removed the monetary excess.

One important issue not mentioned in the Fed’s policy statement was the dollar. Everybody on Wall Street is talking about the falling dollar. They are obsessing about it. And most blame the lower greenback exchange rate on America’s widening trade gap. This is totally wrong. The main reason the dollar has slipped when measured against the euro is that European monetary policy and their creation of new euros is way too stingy; it is in fact still deflationary.

The Fed, on the other hand, has moved from deflation to reflation in recent years, thereby creating plenty of new greenbacks. So euro scarcity value has raised its currency at the expense of the dollar. In essence, it’s not so much that the Fed is too loose as it is that the euro central bank is too tight. Consequently, Eurozone economic growth has averaged a recessionary 1 percent in recent years, whereas the U.S. recovery rate has been 3.5 percent. America lowered tax-rates, but the Europeans refused to do so. Top heavy social spending and excessive regulating of business and labor markets also suppress Eurozone growth. In comparison with the U.S., not only does Europe not work, not produce, not invest, with terrible productivity, their monetary policy is scorched-earth deflationary.

But, Fed officials should stop talking the dollar down. In recent weeks Janet Yellen, Ben Bernanke, and Robert McTeer (before he took the presidency of Texas A&M) suggested that the dollar should fall some more. This is dumb. It may be the biggest reason for the recent dollar decline. And we have learned that the falling dollar relative to the euro is tightly linked to a rising gold price.

As for the trade deficit, the U.S. grows faster than its biggest customers. So we import more than we export. However, exports are rising at a 13 percent pace; a great sign of economic health. Imports are rising even more by 17 percent. We are selling goods and services to China at a 37 percent rate. But the volumes are too small to dent the trade gap. This will change over the next decade.

Meanwhile, America’s profitable investment margins attract foreign private capital inflows from all around the world. Lately foreign inflows have come in around $600 billion, about the same as our $570 billion current account deficit for goods and services. In other words, there is no financing problem at all and no reason to tie the dollar to the trade accounts.

However, it would be foolish if the U.S. Fed started targeting the euro for its monetary policy. If the Europeans are stupid enough to crash their economy, that’s their business. But whatever hedge fund traders may say, the U.S. must not make the same monetary mistake that would wreck our prosperous recovery. Domestic price stability should be the Fed’s strategic goal. As long as they follow interest rates and commodity movements, as Greenspan seems to be doing, then the U.S. will continue along a path of non-inflationary economic growth.