Fed Has Lost Control Over Interest Rates

Last week the world called the tune, and the U.S. dollar danced.

The dollar's tumble and Federal Reserve Chairman Ben Bernanke's attempts to placate overseas investors are the clearest signs to date that the foreign investors who finance the huge U.S. trade deficit have gained significant control over the U.S. economy.

A few more weeks like that, and it will be clear to everyone outside of Washington that the Fed has lost control over U.S. interest rates.

Here's what happened:

On Nov. 28, as the dollar edged toward free-fall against the euro, hitting a 20-month low against that currency and plunging below key support prices in the currency markets, Bernanke got up on the ol' soapbox to say that inflation was still "uncomfortably high," growth in the economy was solid and the Fed's next decision would be whether to raise interest rates again.

That came as a big surprise to financial markets that were anticipating a cut in interest rates, perhaps as early as the first half of 2007. Just that morning, the markets had, in fact, received confirmation of their view when durable-goods orders, an important gauge of the health of the economy, fell by 8.3%. That's the biggest drop since July 2000 and well above the 5% decline Wall Street had expected.

Bernanke's words didn't stop the carnage: Without some proof that the economy was as strong as the Fed said it was, the markets simply tossed off the Fed chairman's comments as a transparent attempt to talk up the dollar. It didn't help that new Treasury Secretary Henry Paulson was out -- predictably -- trying to talk up the dollar at the same time.