The Fed digs us a deeper hole

By Bill Fleckenstein

No shortage of ink was spilled last week about the Fed's quarter-point rate cut. Yet none of it acknowledged the big elephant in the room: Why in the hell was the central bank easing the federal funds rate with (1) the dollar at a new low, (2) oil at $90, (3) gold at $800, (4) virtually every commodity on the planet going wild and (5), despite government statistics to the contrary, inflation raging?

Author, and father, of 'The Age of Turbulence'

Of course, we know why the Fed eased: because it's worried about problems in the financial system. But nothing better illuminates the Fed's position -- between a rock and a hard place -- than its rate cut last week. The Fed cannot fight inflation. It cannot provide for a decent currency. (If there's any levity to be found in the state of the dollar, you'll find it at the end of my column.)

The Fed's policy is to print money, print money and print more money. That's because of what then-Fed chief Alan Greenspan did for nearly 20 years. He bailed out every problem that came along, so we never had a small forest fire. Now we're getting set to have a giant forest fire.

In addition, the deregulation that Greenspan routinely championed is part of the current predicament, as it allowed folks to push problems down the road for a long time. Well, down the road just might be here.

Lower rates on demand

It's been an unfortunate journey that has brought us about as far as we possibly could have traveled since Paul Volcker was chairman of the Federal Reserve.

That's the only conclusion to draw from a story last Tuesday by Wall Street Journal reporter Greg Ip titled "Why rate cut isn't a sure thing: Bowing to market pressure could prolong dilemma for Fed's policymakers." (But the next day, the Fed ignored the current level of inflation to curry favor with the stock market via the quarter-point cut.)

When Volcker was the chief central banker, the Fed, not the market, was in control. Now it appears to be the reverse. As Ip wrote, the decision for policy makers was "between the quarter-point reduction and no cut at all." He then went on to illuminate who's the boss:

"Both courses of action have risks. Perhaps the biggest is that the market's certainty that rates will be cut creates a burden on the Fed to deliver. Ordinarily, meeting market expectations isn't a goal in itself for the Fed. But the current environment is more fragile than usual, and thus the consequences of disappointing the market are potentially more damaging."

Toadies 'R' us

What's clear from this article: At least somebody at the Fed had indicated to Ip that he was concerned about how the stock market would respond to the Federal Open Market Committee decision, which indicates how much the Fed is in the back pocket of speculators.

Running the Fed by trying to pick the right interest rate was never a good idea, but that's what Greenspan did and what Bernanke does now. An even worse way to run the Fed is to be 100% on the applause-meter standard, which seems to be the path we're going down.

Just to show you what a pathetic joke the Federal Reserve is, last week the Mexican central bank raised interest rates from 7.25% to 7.5% -- and the peso has been far stronger than the dollar lately.

That was an attempt to ward off inflation, which is raging around the world. The Russians recently took a page from our playbook: Rather than raise interest rates to fight their inflation problems, they instituted price controls (like the Chinese did last month), though they're supposedly voluntary.

The prestidigitation that minimizes inflation

Look at last Wednesday's report on third-quarter gross domestic product. Our government would have us believe that inflation was running at only 0.8%, which allowed the growth of real GDP to be 3.9%. If the government had calculated the annualized rate of inflation to be 3.9% (probably a low estimate), then real GDP growth would have been zero. One number cannot be incorrect without the other number being incorrect.

So while the government and the Fed pretend the U.S. doesn't have inflation problems, countries around the world are acknowledging their own and trying to deal with them. Of course, we have the weakest currency, so whatever problems the rest of the world has, we have in spades, though we've jiggered the statistics to mask that.

Introducing the xera

Thanks to the suggestion put forth by a reader of my daily column, I have come up with the new name for our currency. Henceforth, it shall be called the xera. That's a combination of Xerox, for the piece of Xerox paper that it is; lira, which in the past was one of the world's chronically weak currencies; and, most importantly, the fact that it sounds like zero. That is ultimately where the xera is headed.