Why the Fed Should Raise the Federal Funds Rate Not Lower it Today

I know it is heresy, but the Federal Open Market Committee should raise short term rates today. We are in a dollar crisis. This dollar crisis is at the heart of the financial crisis. The threadbare currency is the street person who dropped in on the high society party and whom no one wants to acknowledge is present.

Reuven Brenner, a partner at Match Strategic Partners and a professor at McGill University, points out that "few are noticing the fact that, since 2002, trillions of dollars worth of business and U.S.-government debt value has evaporated. This happened because the Federal Reserve has neglected the dollar." As the dollar falls, the value of dollar denominated assets fall in euro and yen and pound and Aussie dollar terms. Little wonder foreign investors want to dump U.S. dollar mortgage backed securities which are at the eye of the storm.

Professor Brenner notes, "Alan Greenspan says that a measure of stability will be restored when house prices stabilize, which may be accurate. But why would capital flow into real estate denominated in dollars that are still expected to plunge?" The same is true of financial assets. He advocates a commodity anchor for the dollar, a position I have long advocated myself.

Given that we are unlikely to get a new monetary system, what should be done? We need a coordinated effort of the Federal Reserve with the other major central banks to support the dollar. To accomplish this with credibility, the Fed would need to show its commitment to fight inflation and to restore the exchange rate. That means raising the federal funds rate target. This would cause a political firestorm, but it would be the only way to calm the financial storm that is swamping the U.S. and limit the economic damage from it.