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Open Letter



On Friday, Stephen Roach, Chief Economist at Morgan Stanley, wrote an open letter to Mr. Greenspan emphatically urging the Chairman of the Federal Reserve to immediately raise the fed funds rate in one move from 1% to 3%. I have written before that real rates are negative and that the "theoretical" fed funds rate is 3%, so for my part I strongly suggest everyone read this letter.

The letter is very straightforward, the major innuendo and relevancy coming in one paragraph:

"There's something else I don't get. You are very upbeat about economic prospects, recently presenting a forecast to the U.S. Congress that real GDP would rise 4.5 percent to 5 percent over the four quarters of 2004. This is solid growth for any economy. But you still insist on keeping interest rates amazingly low. A normal economy needs normal interest rates. With your forecast, you should have nothing to be afraid of. Am I missing something?"

Mr. Roach is being rhetorical and is not missing anything. He knows that this recovery is built on high debt requiring massive amounts of liquidity to spur inflated asset prices. The economy is like a balloon with a leak: it needs a constant flow of new air to keep it inflated. Today it takes $6 of new debt to create $1 of GDP, an astounding number.

Mr. Roach is one of the few economists not willing to stand idly by and watch what is happening. He laments at the lack of independence, which is legislative in nature, exhibited by the Federal Reserve in an election year.

His concern for current economic policy is evident in his letter. I urge you to read it.
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