February 4, 2008

Mr. Bernanke:

Re: Impact of Low Interest Rates on the Strength of the Dollar

This letter argues that The Federal Reserve, the central bank of the United States commonly referred to as the Fed, might have made a grave set of mistakes in 2007 and January 2008 by cutting the Fed Funds rate to the new low of 3.00% – 3.50% in order to stimulate the US economy. These actions may have the opposite effect by causing a downward spiral in the stock market and economy by keeping the Dow Jones Industrial Index below 12,500 for much of 2008 and by negatively impacting the bond market, producing a downward sloping yield curve which will make it difficult to sell long-term 30 year treasury bonds possibly causing the Chinese and others holding US Treasury assets to sell in favor of euro denominated government liabilities. January 30, 2008 decision by the Fed to bring the discount rate to new lows runs the risk of spurring a switch in global markets from the dollar to the euro or other currency.

The Fed should not sacrifice the bond market for the stock market by over reacting to current economic trends and pressure to provide stimulus and incentives to bail out banks caught in the midst of a national mortgage crisis without giving serious thought and consideration to the long-term economic consequences and effects of such decisions. Destroying the bond and deposit markets in favor of the stock market at a time when the Fed should be raising the fed funds rate will have the long-term effect of weakening the dollar causing further rise in oil prices that will fuel inflation in the country and aboard.

Due to recent decisions, we can now look forward to oil prices going over $100 per barrel and prices at the pump above $4-$8 per gallon by summer and year-end 2008, without the positive benefits of countervailing base-line income stabilizing effects that higher interest rates bring to mutual funds, fixed income securities depended upon by retirees and deposit holders all over the country and abroad that are at the base (i.e., floor) of the global economy, at least the portion tied to the dollar through trade relations. Should these fed fund rate lowering trends continue as planned, the consequences on domestic inflation through increased demand in consumer spending and non-investment-grade-backed trade financing could be staggering.

Under this low interest rate scenario that the Fed has introduced in the face of a rapidly devaluating dollar, we are destined to see higher gas and food prices in spring, summer and winter of 2008 going into 2009. In addition, the lowering of the fed funds rate to 3.00%, at this particular time, will not help the mortgage crisis either, which for the most part is a done deal.

In fact, it could have the reverse effect by generating more speculative refinancing by attracting home owners to speculate with questionable lending institutions. The mortgage problem needs to be dealt with through fiscal not monetary policies by restructuring the banking and mortgage sectors and putting blame where it belongs through criminal charges for banks that exacerbated the problem through predatory and other unconscionable lending practices. The Federal government needs to take steps to stop foreclosures by providing temporary relief and aide to distressed mortgagees, but not to the banks and financial institutions that are responsible for the problem. This action should not have any bearing on the Fed’s decision on monetary policy that should squarely focus on keeping inflation low by maintaining the strength and value of the dollar, especially since the United States imports more than it exports at a tune of about $63.1 billion as reported in the New York Times in January 2008.

We are “upside-down” in our national and domestic financing and monetary policy no different from those who lease vehicles at present value prices that are far greater than the social value of the economic unit they have purchased due to unconsciousable industry rapid, sales oriented, depreciation accounting policy. This serious socioeconomic disease that started with mortgage and lending institutions and trillion dollar war budgets, that is no different in structure, modus operandi and reversed political framework as the Latin American Debt Crisis of the 1970-80s, has spread to the level of the Federal Reserve System infecting the heart of our monetary system that modifies, influences and adjusts supply, demand and prices of the value of goods and services produced in America and abroad through open market and other monetary operations, including the setting of the fed funds/discount rate that drives interest rates in euro-dollar markets; thereby impacting the strength and demand for the dollar.

The Federal Reserve needs to rethink its strategy and recent and past decisions of lowering the fed funds rate to 3.00% and start raising interest rates to reach 4% by spring, 5% by start of summer, 6% by fall and 8% by December 2008. This would help to protect the dollar from further unnecessary erosion and stabilize the trade deficit that has been seriously impacted by recent increases oil prices. Increased interest rates will help stabilize food prices and stem demand for trade goods and other non-productive investments and speculative asset and liability swapping that lower interest rates are sure to foster and generate in the short-term, fueling electrifying volatility and uncertainty in global financial markets without the necessary off-setting high-grade, long-term investments in the economy and economic infrastructure that is urgently needed.

The risks and consequences to the American economy and global financial markets are too severe to ignore any reasonable set of ideas that could work or make practical common sense without resorting to speculation or wishful thinking.

Maintaining low interest rates over the past four (4) years have led to the development of an environment of permissiveness and callousness in banking and financial markets and in the domestic economy in particular. Hence, the Federal Reserve Bank is largely responsible for the crisis in the housing market and should share in some of the blame and responsibility for the development of that huge problem.

WHY SHOULD THE DISCOUNT RATE INCREASE?

If interest rates stay low near 3.00% for the foreseeable future, which is not sustainable, the dollar will fall, oil prices will rise dramatically, heating oil will be expensive in winter 2008-09 and the trade imbalance will continue to grow; the dollar might experience an unusually high level of “dumping” by China and others in favor of the euro, particularly with recent winter (snow storm) weather related problems – that is the worst case scenario!

If interest rates rise, there will be a temporary mini-crisis and shake-out of bad and speculative investments, banks will have to tighten-up and restructure, bad investments will fall by the way side and the play on housing assets will stop immediately! The dollar will rise, corporate liquid investment portfolios will do better adding secure dependable income to corporate bottom line, public savings will increase, demand for fixed income assets will rise, the stock market will stabilize at about 12,500 by year-end where it should be, not the 13,700 speculative high that that the Dow reached last year, retirees will have better more secure income, mutual funds and pension plans that hold more fixed income securities will do better as a result, states, cities and municipalities will not have access to cheap money anymore, so state and local governments and municipalities will have to tighten the belt and make sound budget and financial decisions in the future – in short the period that sustained Reckless Monetary Goals and Objectives will end and discipline will return to the economy and global financial markets.

The fed funds rate should perhaps be between 6% – 8% by year-end going into 2009 in order to bolster the dollar and allow legitimate investments that seek to manifest at reasonably competitive hurdle rates with respect to the international cost of capital. This would allow the incentive and stimulus package that passed the House and Senate to work in its own right. This is the proper way to go, that is, simulate the economy through sound fiscal reform and policy that promotes a Keynesian approach to public spending and focus attention at the Federal Reserve level on strengthening the economy through monetary policy that strengthens the dollar and lower inflation at the same time.

The president and Congress should fix the problem of a weakened economy through fiscal policy and reform enforcing the use of prudent business practices as well as launching an aggressive investigation into the cause of the mortgage crisis to ensure that legal, accounting and regulatory rules were not violated in the process.

At this stage of the global economy, the US Federal Reserve system should be focusing on using monetary policy that supports the dollar vis-à-vis other currencies, since that is the most critical issue facing the American economy today!

It will take another two years through 2010 or beyond before the American economy comes out of the slump stemming from the massive exportation of jobs and business opportunities abroad that was supported by this and previous administrations without proper checks or voice from the Federal Reserve System.

In this regard, the Fed should take a long-term view to the problem of economic stability and not jeopardize tomorrow’s future or run the risk of possibly making things worst by going after short-term fixes and economic stimulus activities that do not meet the long-term economic needs of the nation. Such near-sightedness has the potential of further weakening the economy, reducing the productive capacity of the country and increase poverty in America.

Thank you for considering this opinion.