Between a rock and a hard place

I never thought I'd find myself writing these words, but here goes...

 

Pat Buchanan is right.

 

Not about everything, probably not even about most things. But on this one issue, he could hardly be more right.

 

The recent hand-off from Alan Greenspan, the maestro of the Global Economy, to Fed Chairman Ben Bernanke may turn out to have been a lateral far behind the line of scrimmage, leaving Bernanke holding the bag for a recession for which he is no more responsible than was the hapless Hoover.

 

Buchanan's point is that the Federal Reserve is now between a rock and a hard place. The softening economy, subprime debt going bad on the books of major banks, the inability collapse of the housing bubble, and the credit crunch, all taken together would normally make rate cuts a no-brainer for Bernanke.

 

But the Fed is responsible not only for the national economy. It is responsible for defending the dollar, which represents the real savings and wealth of the nation. And that dollar has lost more value in seven years than in any similar period in modern history. A euro, worth 83 cents the year Bush was elected, has risen in value to $1.47.

 

To put it another way, the Dow Jones Industrial Average spent most of 2000 around 10,000, and is currently a bit over 13,000. That sounds like a 30% gain, or about 4.3% a year -- not great, but not terrible. But when you account for the weakening dollar, the DJIA has actually lost 27%! Without getting deep into economic and monetary theory, the ideal solution to this would be to raise interest rates and reduce the monetary supply.

 

So Bernanke is faced with a no-win scenario. If he lowers interest rates, the economy is stimulated and people keep their houses, but we may be pushed into 1970s-style stagflation, or even an Argentina-style currency collapse . If he raises rates he fights inflation, but pushes the country into a recession, potentially a very deep one.

 

Personally, I think a recession would be far preferable to currency collapse, but for various reasons of political expediency, it appears that Bernanke is more concerned about avoiding a recession.