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Farrell: Since When Does the US Take Lip Like That?!

Monday, 22 Nov 2010 | 10:01 AM ET

Doing what other US officials should have been doing all along, the Force, otherwise known as Gentle Ben, struck back last week and defended US monetary policy. But more importantly, in a very nice way, he told other nations to look to their own houses andback off on the criticism of the US.

He argued currency undervaluation by China and other emerging markets is at the root of imbalances in trade and "represents a growing financial and economic risk."

I'm not a fan of QE 2 (quantatative easing), but I am a fan of the independence of the Fed, and I am appalled at the attacks the US has been passively accepting internationally because we seem to want to be everyone's friend.

That doesn't work.

One G20 official suggested out loud at the last meeting that the US should confer with that body before embarking on a QE type of program. Our Fed, the architect of QE, doesn't confer with its own government (Fed independence), and since when does any country confer with another about its own economic path?

And since when does the US take lip like that?!

There is a valid question about what the Fed's mandate should be and it is going to be a persistent issue. The 1978 Humphrey-Hawkins bill required the Fed to pursue the dual goals of 1) stable prices, and 2) full employment. The dual mandate was not handed down to Moses on the Mount. It is man-made.

"I'm not a fan of QE 2, but I am a fan of the independence of the Fed, and I am appalled at the attacks the US has been passively accepting internationally because we seem to want to be everyone's friend."" -Soleil Securities Group, Vince Farrell

Recently, the Fed has made it clear it wants higher inflation (that's addressing the price side of the equation). The Fed used the almost flat-line year-over-year increase in last week's announced Consumer Price Index (up only 0.6% year-over-year, an all time low) as justification for embarking on QE 2. But announcing it wants higher inflation seems to have scared people holding bonds. Instead of driving interest rates down, rates have risen from around a 2.4% yield on 10-year Treasuries to the recent 2.9% level.

Bill Dudley, President of the New York Fed and a former Goldman Sachs chief economist, used the very high unemployment rate of 9.6% as justification for employing another round of QE. The theory is money injected into the system will lower rates and encourage banks to lend and people to borrow and jobs will be created. But the money being injected seems to be convincing people that inflation is the next issue we will have to face as too much money chases too few goods, and rates are going up, not down.

Senator Bob Corker (R-Tenn.) has called it the Fed's "bipolar mandate."He was quoted in the Wall Street Journal as saying, "The pressure to bring down unemployment using money creation. . . will complicate the task of maintaining stable prices. As the Fed pushes money out the door, whether or not there is an economic demand for more dollars. . . the long-term effect may be inflationary as too much money chases too few goods."

In other words, the two mandates conflict with each other.

To try to lower the rate of unemployment requires policies that will raise, not lower, rates. The US central bank is the only one with a dual mandate. The others have the sole job of trying to achieve stable prices. This will be another issue for the Congress to put on its agenda.

But the lame duck session first has to grapple with whether to renew long-term unemployment insurance, or not. If not, 2 million people will run out of benefits November 30 and several million more in the succeeding weeks. Whither goest tax rates is sort of important, and that's on the docket, as are Medicare cuts for doctors and a continuing resolution for money to keep the government operational. Both Senator Reid (D-Nev.) and Representative Pelosi (D-Ca.) have said they will try to get an up-or-down vote on an extension of the Bush tax cuts for all but the rich. That would force the Republicans to vote against it and the Dems will have a nice sound bite for next election of Republicans voting against tax cuts for the common man. You have to admire the maneuver.

Ireland, Portugal, Spain and maybe Italy will be in the news, and the dollar, which was supposed to weaken with QE 2 to support our exports, is doing the opposite and may continue to strengthen against the euro as those debt problems play out. Also, look this week for an upward revision to Q3's GDP from 2% to about 2.3% since inventory accumulation was stronger.

Vincent Farrell, Jr. is chief investment officer at Soleil Securities Group and a regular contributor to CNBC.

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