Fed easy policy to stay on hold while other central banks firm

Even with actual and expected firming moves by foreign central banks, markets are increasingly dismissing the prospect that the Fed will soon begin a firming trend of its own intended to contain inflation and strengthen the dollar. A speed up of inflation globally most recently prompted the Central Bank of Mexico to firm, the European Central Bank to hint at a rate rise in its July 3 meeting and the Bank of India and others to suggest a firmer policy stance is coming. The reduction of energy subsidies in a number countries, including India and China, adds to price pressures but, like central bank firming, is an effective form of economic constraint that will slow global growth and energy demands. But, contrary to this trend, the Fed is now increasingly thought likely to maintain its current easy policy stance.

Despite a series of statements by Fed Chairman Bernanke and other Fed and Admistration spokesmen hinting that "receding" financial threats permit a new anti-inflationary pro-dollar Fed stance, the markets are coming to think otherwise. They recognize that the Fed's hands are essentially tied to an easy monetary policy. As I indicated in my blog last week, how could it be otherwise with the continuing credit crunch, housing debacle, necessary bank and investment bank capital restructuring, and developing recession. The Fed is either merely misleadingly feinting at a new policy direction to achieve the desired effect without actually moving in that direction or, far less likely, about to blunder badly.

While the Fed has certainly blundered numerous times, easing when it should have firmed and firming when it should have eased, to firm now would be a particularly egregious policy move for housing, the financial sector and the economy. Unless of course the Fed really wanted to accelerate the economy's glacial decent into recession, hoping to avoid taking responsibility for it, while taking credit for an anti-inflationary impact. Some may consider such a tactic not only adroit, but in the best traditions of devious central bankers. But, that is too deceptive and dangerous a political game to be played ahead of a Presidential election.

Also, the Fed has supposedly shifted to a more revealing, transparent type of policy setting behavior. To return to an opaque, indeed duplicitous, policy now, would be a throwback to an earlier Fed policy setting approach.

A little bit of financial history may be appropriate here. I recall when Arthur Burns (who had previously been my Economics Professor at Columbia University) was Fed Chairman and the Fed did not pre-announce its policy moves or even their direction. As the so called "Fed watcher" and Financial Economist at the time at the Chase Manhattan Bank, I detected in the data a policy change that the Fed was forced by economic circumstances to quickly reverse and I said as much. When questioned on my contention, Fed Chairman Burns publicly denied that a Fed policy reversal had taken place. He said neither the first move I had cited, nor the second had actually occured. It was all, he said, merely in the imagination of the Fed watcher, meaning me. Some three months later, when the Fed Quarterly report of Fed policy initiatives was published, both the first Fed policy shift to a new direction and its subsequent reversal were there revealed for all who cared to see it. That was certainly not the first Fed deception, nor was it the last.

The need for a continuing easy, supportive Fed policy is currently obvious. Indeed it is evident, even with mounting risks that inflation in energy and food will temporarily filter through to other prices and wages before economic weakness generally is able to effectively supress inflation pressures and expectations. The clear reason is the continuing fragility of the US financial system, compounded by mounting consumer financial and economic distress, rising unemployment, and the continuing slide-off in housing and autos. The adverse economic consequences of the negative wealth effect implicit in the downtrend in equity and home prices and the rise in energy and food prices, swamping the positives of fiscal and monetary policy, have yet to be felt or adequately apreciated. Eventually economic weakness and recession will supress inflation expectations and inflation reality. It would help lessen food inflation faster if human and animal food were not foolishly diverted to energy. Biomass can be an effective source of energy, but only if marginal land not suitable for food crops are employed to grow high energy content crops using relatively small quantities of water. Switchgrass and algae are excellent candidates, and they would solve the excess co2 problem.

Though moderating demands globally should lead to somewhat lower prices for energy and other commodities, concerns over the potential for an Isreali air strike on Iran's nuclear weapons facilites is likely to keep energy prices artifically high. That should accelerate the global economic slowdown implied by the sharp downtrend in many developing world equity markets. Those lower equity prices should not be viewed as an investment opportunity until the economic and financial developments they are forecasting are actually realized.

George Soros, in my view, is right on in his concern that the current break in various markets could be the bursting of a broad prolonged multi-market bubble with its potential of dire consequences. That risk, even if we are fortunate enough to dodge the bullet, should not be taken lightly. Investor caution remains appropriate.

Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport New York 11731

E-mail Adress: philipbraverman@Gmail.com