Federal Reserve and Monetary Policy: If I had the money I would $hort the dollar.

I’ll use the following papers as references: Governor Frederic S. Mishkin
At the Business Cycles, International Transmission and Macroeconomic Policies Conference, HEC Montreal, Montreal, Canada
October 20, 2007
Headline versus Core Inflation in the Conduct of Monetary Policy (a Taylor rule is given in foot note #2)
and
Discretion versus policy rules in practice John B. Taylor.

I’ll remind readers about Greenspan’s interest rates conundrum. The problem, my opinion, is in the output gap. The output gap is a measure between real GDP and trend real GDP. However, the US of A’s large trade deficit makes the output gap highly uncertain because economic conditions on “Main Street” are inhomogeneous. The Method of Moving Frames: See Wikipedia (for resource links) indicates that a component that is transformed has many elements.

Example: a producer uses a electronic component from another market. That component has a value added chain (topological lift) associated with it. Yes, using a component from the other market lowers the price and releases the resources used in the producers market however, those resources (mainly people) have to be addressed by an economic policy. Bush’s current economic policy (Oct 2007) is to let the market handle it. The market created a two tier labor (people) system. See my Neoclassical blog for details of group transformation and group convolution.

In other words, The FOMC should be using their discretion not policy rules.

There is another credit crunch coming. Sec of Treasury Paulson has made sure of this event. He said that there is a mortgage meltdown. I think it is going to come from the credit derivatives market. See OCC’s Quarterly Report on Bank Derivatives.

It’s the total risk-based capital that gives me the chills.
Total Risk-Based Capital: The sum of tier 1 plus tier 2 capital. Tier 1 capital consists of common shareholders’ equity, perpetual preferred shareholders’ equity with noncumulative dividends, retained earnings, and minority interests in the equity accounts of consolidated subsidiaries. Tier 2 capital consists of subordinated debt, intermediate-term preferred stock, cumulative and long-term preferred stock, and a portion of a bank’s allowance for loan and lease losses.

I bet that subordinated debt has to be reprised.

It’s going to be a struggle between those who want to $hort the dollar and those who want to support the dollar in order to protect their dollar denominated a$$et$. There is no support for the dollar from the Bushies. If one assumes free market principles are executing their own strategies, with no collusion, then the time average price movements will indicate which side has the most money, leverage and guts. The general trend is dollar weakness.

Of course, the 1,000lbs Gorilla (China) can change all that. A possible scenario is China buying a financial institution (example; Bear Stern) from which it could support the dollar without having the Federal Reserve looking over its shoulder. The Security and Exchange Commission is much easier to deal with. Considering the fact China will be doing Bush’s job, the SEC will be very willing to bury all complaints in its procedural process.