The minutes of the latest meeting of the Board of Governors of the Federal Reserve System released today (news clips below) show that the Fed is confused and worried because its interest rate policy is unable to contain inflation in prices. But the oil and energy prices have fallen dramatically. Even real estate prices have fallen badly.

So what is worrying the Fed?

The best way to understand government officials anywhere in the world is to read in between the lines, by applying common sense to decipher whatever is officially uttered. The one-year rate of interest that the Fed has decreed to be 5.25% is much higher now than the ten-year spot yield of 4.78% which is determined by market forces of supply and demand for money. In fact, the ten-year yield had dropped to 4.5% a few days ago. It rose to 4.78% only after the Fed repeated many threats to raise the one-year rate that it controls.

Because the Federal Reserve does not control the long term rates of interest, it can only threaten capital market participants about risks of inflation or deflation. Why are the capital market participants then not heeding Federal Reserve's current threats on inflation risk? In fact, the capital market seems to be defiant towards Federal Reserve's threats on raising interest rate to contain inflation. This defiance has led the Fed to worry about its threats not being credible.

Why is the Fed issuing threats that it considers not credible? Why does the Federal Reserve want the long-term rates of interest to rise? What is the goal of the Federal Reserve and what it should be? These are analyzed in detail in Prosperity. Simply put, the rate of interest is the price of fiat money. The current price of future dollars are dictated by the rates of interest. The Federal Reserve wants these prices to rise. The American households who are net borrowers bear the brunt of rising prices of dollars they have borrowed with promises to repay in future. Some estimates tell that 95% of American households are net borrowers. In fact, the government should collect data on net assets of households to know precisely the percent of households who are net borrowers. Such data are not collected by governments world-wide, despite the risk to prosperity and stability of humanity due to suppression of the truth.

Why does the Federal Reserve seem to want to penalize the vast majority of households? Some students in one of my classes at the University of Illinois raised this question in the past. Some other students in the same class answered that raising interest rate helps only those who have net credits, that is, those who are mostly the rich. The conclusion in my UIC class was that the Federal Reserve merely protects the interests of the wealthy who have amassed perhaps usurious credits supplied to the vast majority of net borrowers.

The wealthy have amassed so much credit that they are willing to lend on a long-term basis at lower rates of interest (prices of future dollars) than the Federal Reserve decrees. This is precisely reflected in the falling long-term rates (inverted yield curve) despite the Federal Reserve raising the one-year rate.

Then the question is why the Federal Reserve is so defiant as to dictate higher short-term rates or warn about inflation risks when consumer prices are falling (as now) or deflation risks (as in 1999) when consumer prices were deflating. In1999, the Federal Reserve was concerned about rising stock prices that enriched the vast majority of households, making many middle class Americans rich. The Federal Reserve has been concerned during 2005-06 about rising real estate prices which also have enriched the vast majority of households.

So whenever the vast majority of households tend to enrich themselves, the Federal Reserve seems to be worried. Is it a spurious correlation? This should be the biggest confusion in the modern era because the Federal Reserve (created in 1913) is supposed to protect the best interests of the vast majority in a democracy.

There is still a valid latent reason for why the Federal Reserve may want the price of dollar to rise, but cannot openly say so. It is that the federally insured U.S. banks have massively depleted their capital or that the risk of such capital has gone up due to mortgages and derivatives while the wealthy investors have withdrawn from these banks usuriously hiked salaries, bonuses and perquisites by creating short-term bank profits and have transferred the same to stocks, bonds, real estate and emerging market assets for protection. The only way to attract capital back to the federally insured banks is by raising the rates of interests on deposits through the Federal Reserve fiats. Unfortunately, though, the Federal Reserve cannot set the long term rates of interest.

The risk of capital in federally insured banks could be the inexplicable concern of the Federal Reserve in raising the short-term interest rate and guiding the market to raise long-term interest rates. But what the Fed is doing is not a solution at all to the problem that is perhaps brewing under an ostensibly benign facade of economic growth of the U.S. economy. It is because the wealthy that have withdrawn from the banks are very smart and the rest have little savings to deposit in banks to buttress potentially eroding bank capital.

The real solution based on common sense has been offered in proposal on Safe Banking to all responsible members of the U.S. Congress in 2003 and to White House in 2005. Let's pray that common sense translates to wisdom and law at the end.

Sankarshan Acharya