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Mark Thoma points out that the Federal Reserve Board is now stocked entirely with Bush appointees, which isn't really how the Fed is supposed to work. But he doesn't go into why.
Fed governors serve staggered 14-year terms, so clearly the idea is to keep any one president from appointing the entire board. But nowadays Fed governors almost always leave before the end of their terms.
... which isn't really how the Fed is supposed to work.
A few days ago an unusual event took place: Paul Volcker, the mythical U.S. Federal Reserve Board chairman from the Reagan years, criticized the policy of the current Fed chairman, Ben Bernanke, in a speech to the Economic Club of New York.
Just so you grasp how extraordinary this was, you should first understand that normally a past Fed chairman scrupulously avoids saying anything at all about current Fed policy - for the simple reason that the current Fed chairman's words are one of his most important tools: They can sway markets.
This ability does not fade entirely when a Fed chairman leaves.
So when a past Fed chairman speaks, his words can clash with those of the present one and make that one's job difficult. Out of professional courtesy, past Fed chairmen therefore keep quiet; Mr. Volcker especially - the man who hiked interest rates to 20 per cent to kill inflation, at the cost of a deep recession. But last week Mr. Volcker spoke his mind bluntly. He said, in effect, that the current Fed is not doing its job.
This would have been unusual enough. But Mr. Volcker went further. Not only is the Fed not doing its job, he said, but it is doing the wrong job: It is defending the economy and the market, instead of defending the dollar. And just to stick the knife in, Mr. Volcker added that this bad job now will make the real job - defending the greenback - much harder later. It'll cause even greater economic suffering.
In plain words, Mr. Volcker implied that the current Fed is not only incompetent, but that its actions are dangerous…
Up to now Mr. Volcker kept quiet, but no more. In his speech he just said, in effect, that the recession is not the Fed's problem. It's the government's. The Fed's job is to defend the currency and fight inflation - exactly the opposite of what this Fed is doing. The solution? Raise interest rates, Mr. Volcker practically said, no matter the consequences now, because if you don't, you'll have to raise them even more later, with even more awful consequences.
Will rates indeed rise? I have no doubt they must. Not now, perhaps, but at the end of this year or the beginning of 2009, with a new president in the White House. The stock market, which usually looks six to nine months ahead, already understands this and may soon react. In fact, when Mr. Volcker's words sink in, the markets are likely to sink as this bear market rally ends.