Control our oil supply and you get a say in our monetary policy. Not necessarily a good thing, as the aftermath of Treasury Secretary Henry Paulson’s trek to Saudi Arabia proves.
What follows is a combination of hard fact and my own surmise, mixed together so as to shield the usual highly placed, reliable source.
There is something called “the Fed family.” Not as shady as a Mafia family, but far more powerful. Its members include Chairman Ben Bernanke and the six other members of the Board of Governors, appointed by the president of the United States; the presidents of the 12 regional Fed banks, five of whom get to vote on interest rate changes; and several influential alumni who are frequently consulted by Bernanke and the White House.
In times like these, when recession looms, inflationary pressures are rising, and many banks are, er, teeter-tottering, many of the Fed family members weigh the several dangers differently.
Some worry about rising unemployment, and want to keep interest rates low. Some worry more about inflation, and want to raise rates; others worry about the health — or lack of it — of the banks, and favor the sort of open-handed policy that Bernanke has adopted to provide liquidity to the banks.
Still others worry that bank bailouts will create moral hazard and produce even more reckless lending behavior. Gone are the good old days when benign economic conditions led to virtual unanimity of views.
So far, so obvious. But two things are not so obvious. The first is the intensity of the battle within the Fed family. The Board of Governors worries about the soundness of the banking system.
The presidents of the regional banks worry more about inflation than anything else. The members of the monetary policy committee worry about everything.
And the alumni sit on the sidelines, rather like in-laws, sniping or supporting the chairman, depending on their view of each of his actions. Not a bad system, messy though it is.
Enter Hank Paulson, the Saudis and the White House. Someone has to find customers for the billions in Treasury IOUs that result from our ongoing federal budget deficits. That’s Paulson’s job, making him the nation’s No. 1 bond salesman.
The Saudis are among his most important customers. But the decline in the value of the dollar is steadily reducing the value of the dollar-denominated bonds they hold.
So Paulson decided to go to Riyadh late in May to soothe some ruffled royal feathers. He was told, “If you want more oil, do something to shore up the dollar.” Not unreasonable: The falling dollar reduces the purchasing power of the bits of paper the Saudis get for their oil.
Paulson brought that message back, got President Bush and Vice President Dick Cheney to agree, and started talking up the dollar. But the story doesn’t end there.
Higher interest rates not only boost the dollar, they make it more expensive for the banks to raise the new capital they desperately need. Bank shares plummeted. The members of the Fed family who worry most about the stability of the banking system saw meltdown in America’s future. Talk of interest rate increases had to stop, lest things in the banking community go from bad to worse.
Stop it did when the Fed last week acknowledged that it is worried about inflation, but added that it “expects inflation to moderate later this year and next year.”
No interest rate increase needed, at least unless the inflation indicators head toward the sky. Shaky banks heaved a sight of relief, and returned to the chore of identifying still more of the dicey loans on their books. The Saudis watched the dollar sink.
The ball is now in Paulson’s court. He has the power to intervene directly in the currency markets, and buy dollars. But he probably knows that such interventions rarely succeed in “fighting the market.”
So he is reduced to trying to convince his royal customers, who kept their end of the bargain, that merely by talking up the dollar, backed by the implied threat to intervene, he is strengthening the dollar. And will continue to do so.
This is the stuff of which good novels aremade. But it is not fiction. The Saudis have now extended their influence over oil prices to U.S. monetary policy. If another reason for America’s politicians to end what President Bush calls the nation’s addiction to oil is needed, surely this is it.
