Most observers see the Fed as balancing inflation risk with the needs of
domestic economic growth in making its decision on the U.S.' key target interest
rate.
We see something far more serious-a run on the dollar in 2007 and a risk, for
the first time in 99 years, of a dollar default.
We believe this possible catastrophe now places the Fed in a real fix and will
dominate its thinking as we move into 2007.
Today, Bloomberg reports mixed items on domestic economic growth. Interestingly,
it also reports that an expected cut in the Fed rate had prompted a further fall
in the U.S. dollar versus the euro.
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Financial Intelligence Report has long forecast, against the main
stream, that "stealth" inflation is stalking the U.S. economy. We have therefore
forecast a rise in interest rates in 2007.
We have also referred to the concern of Fed Chairman Bernanke, his two immediate
predecessors as Fed Chairmen and of the presidents of some regional Feds, about
inflations risks in the U.S. economy.
Against this, we have highlighted the negative effect of the housing slump upon
economic growth, which would encourage the Fed to lower rates.
[Editor's Note: Protect yourself from the inflation lie.
Go here now.]
Strangely, the long bond market roared, expecting lower inflation. Meanwhile the
stock markets rose expecting lower rates.
Recently, however, the bond market has sold off on renewed inflation fears and
the stock markets have eased on expectations of slower economic growth.
Unfortunately, we agree with both these fears, which amount, as we have warned,
to the dreaded virus of stagflation that afflicted us in the 1970s.
This places the Fed in a real fix.
As stated, we see a probable run on the U.S. dollar in 2007, taking center
stage, in dictating future Fed rate policy.
Many central banks, corporations and investors are diversifying their cash
reserves into the euro, putting downward pressure on the dollar.
[Editor's Note: Can Ben Bernanke avert the coming currency crisis?
Go here now.]
In addition, a growing number of oil producing nations (Iran and Venezuela-see
more in FIR) are demanding euros in exclusive payment for their oil.
The euro is run on Germanic (anti inflationary) lines by the European Central
Bank (ECB) which has, unlike the Fed, only a single mandate, to keep inflation
at bay. They can therefore be expected to raise euro rates, even to the
detriment of economic growth in the E.U.
The ECB is reported to be likely to raise rates further, putting yet more
downward pressure on the dollar.
China (holding some $700 billion in dollar reserves), fears further decline of
the dollar, but is willing to bargain its ability to cause a dollar run and
possible default, in order to keep American consumer markets open to its cheap
products against an antagonistic Democrat-controlled Congress.
We believe that the sum of these factors places the Fed in an unenviable dilemma
over interest policy.
As previously reported in this column, we feel that, by leaving rates on hold in
the second half of 2006, while inflation appeared to fall by some 30 basis
points, the Fed in effect has tightened real interest rates by 0.30%. However,
this effect fell below the radar of the mainline media.
What also appears to have escaped media attention is that it is neither
inflation nor economic growth that will dictate Fed policy as we move into 2007,
but defense of the dollar.
Defense of the dollar is a major shift in policy that is likely to dominate Fed
thinking in 2007 and result in an upward bias in interest rates.
We should all feel great sympathy for the Fed Chairman Bernanke when he returns
from Christmas to defend the U.S. dollar and at the same time, try to balance
the economy.
In the meantime, we take this opportunity to wish all our readers a very happy
Christmas.
Editor's Notes:
