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Bernanke's Mandate, A Contradiction

Amidst all the hypotheses and strategies of guys like myself, the most recent security to have stolen the limelight must be currencies. It's no secret that the U.S. Dollar has been falling against nearly every major currency throughout the world over the past six months, however it's soon to become a bigger issue, having been publicly addressed by Fed Chairmen Ben Bernanke. In a speech on Monday, the Chairman explained that the Fed is "attentive to the implications of changes in the value of the dollar", in an attempt to "talk up" the value of the Greenback. 

USD 11.17.09, U.S. Dollar Index,

Bernanke's Mandate

The Fed Chairman went one step further to assure the audience at the Economic Club of New York that his board of governors would "continue to formulate policy to guard against risks to our dual mandate to foster both maximum employment and price stability." 


The Fed's Choices

While the Economic Club might have bought it, the mandate is nothing short of contradictory and insults the intelligence of the market. Regardless of the billions of dollars the Fed extends or withdraws from the GSE's, the passionate Bernanke yarns of dollar strength, and Obama-talk about the importance of jobs, the Fed has these simple two options... keep the Fed Funds at 0% or raise it.

0% Fed Funds Rate

If the Fed keeps the rate at 0% the U.S. economy may see a peak in the headline unemployment number sometime in mid 2010, thus addressing the jobs end of Bernanke's mandate, but not without triggering asset appreciation all across the world. This was a successful exit strategy to the prior recession in the U.S., allowing businesses to invest at cheap rates and create jobs for consumers to invest back in the appreciating assets (homes). However 0% rates are currently only allowing institutional investors and governments to borrow funds, who have then invested them in risky assets such as U.S. Equities, Commodities and Emerging Markets. This carry trade continues to devalue the U.S. dollar and decreases the purchasing power of strapped U.S. consumers.

This time businesses can't secure financing from banks because their balance sheets remain in shambles, prospects for earnings growth are dwindling, and consumers continue to lose their jobs. Data out this week showed Q3 2009 posted a record 6.25% of total U.S. mortgage holders in delinquency, proving that 0% Fed Funds rates offer no comfort to those who need it. 

Quantitative Tightening (QT)

QT is an option and should be realistically considered as the only alternative to severe long term inflation. Critics of this view will cite the PPI (Producers Price Index) core statistic's decline of -0.6% in October as evidence to support a deflationary or neutral environment, yet the true effects of artificially inflated commodity prices won't be felt by consumers for some time. Contrarily, the report showed crude goods prices increased by 5.4% over the same period. Should interest rates remain low long enough to increase already inflated asset prices and consumers remain jobless, the result will be a pinched supply chain. Input prices will continue to rise as output prices stagnate or fall and companies/workers go out of business.

The only responsible option for the Fed is to begin QT now and take whatever pain comes along with it. Australia has already begun raising its Fed Funds target and will soon be followed by others, yet Bernanke reaffirms and extends his window of 0% rates until mid next year or later. Meanwhile the charade of talking up the Dollar and failing efforts to lure China into de-pegging the Renminbi amidst a Sino-recovery founded on the cheap currency.

Talk is cheap Mr. Bernanke and so is the Dollar. Keep the USD from falling further by raising rates and weathering the potential short term pain. Many may hate you in the short run and equity markets may turn south, but we will avoid a decade of stagnation, emerging stronger and faster because of it.

Disclosure: Long TYO