Is the Fed brewing the next crisis?

People walk into a meeting of the Board of Governors at the Federal Reserve in Washington DC.
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People walk into a meeting of the Board of Governors at the Federal Reserve in Washington DC.

Fears of lower-than-expected corporate earnings at a time when liquidity-driven equity market valuations are the highest in a decade are raising questions about the wisdom of the U.S. Federal Reserve's (Fed) near-zero interest rate policies.

Apart from the usual and transitory trading anxieties, the questions of excesses, asset mispricing and imbalances that can be created by a quasi-free money over an unprecedentedly long period (i.e., since 2008) are perfectly valid and understandable.

But it's important not to mix things up. There are two inextricably linked – but administratively and functionally separate – issues here: demand management and a broadly defined market regulation.

The Fed's mandate is clear. It covers economic growth, employment and price stability, as well as the supervisory and regulatory oversight of its member banks.

Other federal agencies are responsible for the supervision and regulation of the rest of the financial system.

And then there is the principle of caveat emptor – the key institutional mechanism in free markets and free economies.

Never mind – blame the Fed

This, however, sounds too complicated to most observers looking for impressive punch-lines. Even those who should understand the difference tend to "explain" everything as a direct consequence of Fed's policies.

So, let's put them in Fed's shoes and ask them the following question: How would they respond – within the policy mandate – to a situation of sluggish economic growth, an actual unemployment rate of 11 percent, an inflation rate of 0 percent, tightening fiscal policy and the dollar's punishing 20 percent trade-weighted appreciation over the last twelve months?

Under these circumstances, how would they justify to the American public an interest rate hike?

Argue in favor of a "preemptive strike" to prevent future inflation flare-ups? In that case, here is what they would have to show.

Read MoreFed members torn over rate hike timing, with some seeing 2016,minutes show

First, they would have to produce credible evidence indicating rising wages and prices as a result of growing capacity pressures in labor and product markets. Second, they would have to demonstrate that the economy's current cyclical conditions are strong enough to support these rising capacity pressures over the relevant policy horizon.

Yes, serious public policy is not made on hunches "this reminds me of …", or on loose talk of "I don't know how we get out of this …"

But just in case you think I am too soft on my former colleagues, let me remind you of what I firmly believe: The extraordinary monetary policy we have now had for about six years is a result of Fed's huge and unforgivable errors leading up to the last financial crisis. The four-fold increase of the Fed's balance sheet over that period was necessary to bail out a poorly supervised banking system and to prevent the country's economic collapse.

Watch the Fed – and the Congress

That is the unprecedented situation we have now – a totally uncharted territory with no Ariadne's thread to lead us to clear exit signs.

Eventually, we shall find our way out, but it is important to remember the horrible lesson we are still going through.

The Fed's Congressional testimonies should never again be deferential love-in sessions we used to have in pre-crisis times. And we should never again abdicate our responsibility for public policy in favor of apparently philosophical beliefs that private businesses won't damage the economy because they would not wish to damage their reputation.

The sad epilogue to that fairy tale is well known: these private businesses (mainly banks) had to be rescued with taxpayers' money to hold the economy together.

And the corollary is this: the Fed is an independent agency of the U.S. Congress whose inadequate supervisory and regulatory oversight during a long period of pre-crisis years allowed systematic and highly damaging errors of monetary policy.

So, while watching the Fed, we should also watch the competence of that agency's supervision by our elected representatives, because the Fed and the Congress are solidarily responsible for the effectiveness of American monetary policies.

Investment thoughts

The Fed is not brewing the next financial crisis; it's trying to put an end to the one it created.

On current evidence, the Fed's policy stance is technically correct, and the timing of any future interest rate change will depend on inflation and activity events.

Guesses about expected rate hikes (June, September, etc.) are poor guides to investment decisions. Despite the S&P 500's near record-high 17.3 price-to-earnings ratio, America's equity market has world beating companies, with an unrivaled liquidity, transparency and investor protection rules.

A long-term bet on fixed-income yields is a bet on U.S. economic stagnation and price deflation. That is a bad bet.

America's key geostrategic interests rest on a strong economy. And that's what it will get, because Americans will accept a moderate inflation in an environment of rising jobs and incomes.