U.S. and European Central Bank Need Better Coordination

No sooner had Federal Reserve Chairman Ben Bernanke given the dollar a much-needed boost by indicating his awareness of the inflationary dangers of a weak dollar then his European counterpart, Jean-Claude Trichet, decided to trump him with an ill-timed suggestion that the ECB may raise European rates first, as soon as next month.

The result? The dollar instantly reversed its nascent gain against the euro, oil prices jumped at an unprecedented rate, and U.S. stocks went into free fall, the plunge exacerbated by the weak dollar. Now no one thinks the Fed will be able to raise rates, and Europe will, further weakening the dollar.

This is likely to bring about precisely the problem Trichet professes to be fighting, which is inflation. Unlike the U.S. fixation on "core" inflation, Europe counts energy and food prices in its inflation measure. Even though the rise in commodity prices has been softened for Europeans by the strong euro, they're still rising, in part thanks to inflationary pressures fueled by the weak dollar.

You could get into a lively argument about whose monetary policy has been right lately, with the Europeans sticking to relatively high rates in the face of a weakening economy, and the U.S. slashing rates in the face of the credit crisis and real estate plunge. But that's water under the bridge. It's time for a coordinated strategy to prevent a global recession that will harm all economies.

It's not enough for the Fed to raise rates on its own. That will do nothing to help the dollar if the Europeans insist on matching or exceeding any U.S. increase. What currency traders care about are the relative values. For a stronger dollar, the ideal scenario would be for the Fed to raise rates and for the Europeans to cut.

I realize that central bankers have many other issues to consider and different masters. But it seems obvious that world economies today are so interdependent that they need to be developing strategies in closer consultation. The ECB's announcement last week, which undermined Bernanke and sent world markets into a tailspin, suggests that much progress needs to be made.