Harry Long's  Instablog

WIth the Federal Reserve worried about its independence (finance.yahoo.com/banking-budgeting/arti...=), it has a Faustian bargain to make: keep its independence, or keep interest rates low.

Essentially, many in Congress would like to see the Fed keep interest rates lower for longer than it might if left to its own devices, in order to stimulate employment. It is a frightening prospect that pressure is being brought to bear on Chairman Ben Bernanke to keep monetary policy loose--the same Chairman who once wrote that the Fed could drop money from helicopters, if necessary, to prevent a severe deflation.

If the purpose of Fed independence is to keep monetary policy independent from politicians, who always prefer inflationary policies, it is essential that Ron Paul's bill, which seeks to audit the Fed (a necessity) is not used as a backdoor method by Congress to gain control over monetary policy.

Bernanke is in a tough position. He wants to maintain the Fed's prerogatives to set monetary policy. However, to do so, he may be tempted to bend to the will of Congress and keep interest rates lower than he might otherwise in the absence of external pressure.

If power is the ability to influence, then Congress, in practice, has huge power over the Fed if it's Chairman allows himself to be tempted to make the Faustian bargain of keeping interest rates low, in return for the maintenance of Fed independence. If Bernanke does not show backbone, Congress would not even have to pass a bill giving itself more power over monetary policy. It would simply have to threaten to do so every time it was unhappy, holding the Fed hostage to political whims. To his credit, Ronald Reagan supported Paul Volcker's inflation fighting stance, however unpopular with Congress. Chairman Bernanke should be similarly supported by President Obama in the area of monetary policy independence.

Distrubingly, the New York Times' Edmund Adrews noted on Novembor 11, (finance.yahoo.com/banking-budgeting/arti...=)

"Voters had become suspicious and unnerved by the Fed because of its trillion-dollar efforts to bail out the financial system, Mr. Frank warned. If the Fed really wanted to survive the disgruntlement in both parties, he continued, Mr. Bernanke would have to step back and let him devise a compromise.

Reluctantly, the Fed chairman agreed to reduce his own visibility on the issue and let Mr. Frank take the lead."

This is exactly the wrong approach for Chairman Bernanke to pursue. Rep. Frank is a shrewd politician. The scenario which is unfolding should be a familiar one to Chairman Bernanke if he has ever been pulled over for a questionable "traffic violation." It's good cop-bad cop. "We'll help you, just stop fighting us." Congress does not want to help the Fed. Like any institution, it wants to expand the sphere of its own authority. Can anyone guess who will have more power under any compromise bill? House Financial Services Committee Chairman Barney Frank.

Compromise on monetary policy is a fool's errand.  Instead, the Chairman Bernanke should take a hard line, conceding that the Fed over-stepped the bounds of prudence in supporting problem banks and agreeing to tighter strictures in that area, while vehemently fighting to protect the Fed's prerogatives in setting interest rates. If the Chairman does not, long-term inflation, and indeed, hyperinflation could result.

Otherwise, if Bernanke succumbs to the temptation of appeasing Congress by keeping interest rates artificially low (which is what most members of Congress really want), he will have given up his power without a fight, and more importantly, compromised the integrity of the very currency whose value he is mandated to protect.

Bureaucracies have a bad record when its comes to a question of the public interest vs. the perpetuation of the bureaucracy. Unfortunately, it looks like Bernanke may have already made his choice. Earlier this week, multiple Federal Reserve officials gave speeches around the country, openly stating that the need to spur jobs was worth the risk of inflation. This is a clear message to Congress: “We'll do what you want, just leave us alone.” It's also a clear message to investors. More inflation is coming.

The Fed needs to educate Congress and to fight for prudence. Higher prices hurt ordinary citizens when their dollars don't go as far. When citizens can afford less, it hurts demand for good and services, reducing GDP growth and employment. It's a simple argument, and it's the right argument. The Fed should make it.


Disclosure:
Long GLD