Flying Pink Unicorns

The direction of interest rates in the coming months.

Well, onto the next few fed meetings. I told Fed Chairman Bernanke that I was opposed to his last interest rate cut, and dissented. He told me to shut and stop whining-- that he had enacted my plan WHOLESALE, and I was quibbling. Well he was right, of course. But he did promise me that the fed was done. "We're followers Dan. We followed right where the markets led us, and now we're going to continue to follow. They are the people, we MUST FOLLOW THEM!" He cried, as he leaned back in his $4,000 leather chair, sipping a bottle of imported spring water. "Well ok Ben," I said, sipping my Diet Pepsi (whiskey is so 1985). "But what's next? We're all going on interest rate vacation right? You and the boys that monitor the financial markets are pulling all nighters, but you sent the FOMC crowd home for the Summer, right?" "Yup. You win again, Dan." "Ok Ben, but please tell me we're also done injecting money, making new guarantees, doing more feel good?" "Only if we fucking have to. We've done ENOUGH! The destruction of the dollar is giving me the screaming heebie jeebies. I aint going down in history as the Fed Chairman who turned the dollar into toilet paper!"

"FANTASTIC BEN! You're heading right where I want to go. I AM SO IN LOVE WITH YOU BEN!" "Um, Daniel, you really scare me sometimes."

So that's where we are. The FOMC is on vacation. The Good Lord himself couldn't move interest rates for the next several months. The next move is very likely up, sometime very late this year or more likely early next year, barring complete abject disaster in the financial markets. At my urging, Ben has widely signalled to the markets that the FOMC is in fact on vacation. "Ok, Ben," I asked, "may I now provide you with the plan for getting the dollar back to being worth something again? When a simple sandwich on a Paris street corner costs literally $18, something is badly wrong." "Shoot."

"Well Ben, my plan for the next 6-9 months is benign neglect. Its very unfortunate, but we can't just raise rates to defend the dollar 28 nanoseconds after we cut them to the floor. We'll look like the gang that can't shoot straight, both to the stock and currency markets. It'd be a disaster, worse for the dollar by far than benign neglect." "Duh," he eloquently replied. "But after we're reasonably sure we're out of the financial markets woods, and we can clearly see the economy rebounding, it'll be time to take some money out of the system. First we can do so via open market operations, just sell some bonds, and seriously slow the growth in the money supply the old fashioned way. The markets will get the hint after a few weeks, that Dollar Sheriff Ben has replaced Panic Ben, and that help is on the way for the beleaguered greenback."

"Next, a few short months later, an initial 50 basis point rate hike. The Federal Funds Rate will still be real low; at 2.5% rates will be WAY below what will be the nominal GDP growth at that time (figure 4.5% inflation and 2% growth, so 6.5% nominal GDP growth and 2.5 % rates-- not exactly restrictive policy!) Then rates will have to go up as fast as they went down, so we can race back towards a slightly stimulative or neutral real rate. So 2009 will, hopefully, involve a series of sharp rate increases."

"I note, Ben, that these rate hikes will likely devastate the equity markets in the very short run, but the sagging dollar ought to spring back to life as the real economy should be able to absorb these blows by then, and of course interest rate differentials between the US and the rest of the world will level out." If the real economy holds up, and the dollar rebounds, the equity markets will of course take care of themselves."

"Well done Daniel my boy. My thoughts exactly. I would add that I would expect that by the time we start frog-marching interest rates north, late in 2008 or early in 2009, that the Euros will be about ready to cry uncle and cut theirs a bit." The shock to the currency markets will be profound. All of their assumptions have been based on the Euros' heads in the sand while we cut rates to the floor. When BOTH of those assumptions go out the window at the same time (with or without coordination)-- well let's just say I'd sell Euros and buy dollars ahead of all this. Oh, and between you, me and the wall, hopefully Obama will have won the presidency and the markets will realize that it is no longer open season on the dollar from the administration. Hopefully Bob Rubin will pull Obama aside and tell him what's what. Lord knows someone has to." "Hey Ben, what happens if god forbid McCain wins?" "Don't even think it. I talked to him by phone earlier this year. He may not be dead serious about even lower taxes, but he's a lost cause on actually raising them. And the spending cuts he's talking about-- well 'puny' about covers it. I think Obama's higher taxes and slightly higher spending are BETTER for the dollar than McCain's Bush light policies. But if you put that up on your fucking blog I'll personally hang you by your thumbs!"