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taking stock

U.S. Federal Reserve chairman Ben Bernanke is about to show why he still deserves the nickname "Helicopter Ben" and why a rather more derogatory moniker, "Banana Ben," may be just as apt.

Mr. Bernanke got the chopper tag after an impassioned 2002 speech about the perils of deflation. The then-Fed governor mentioned a solution proffered by famed Nobel economist Milton Friedman: Simply drop money from a helicopter.

For weeks, the Fed has appeared headed toward the central bank equivalent of unleashing money from the sky, known as quantitative easing. Mr. Bernanke did nothing to dispel that notion at a conference on Friday, saying that the "risk of deflation is higher than desirable."

Further, Mr. Bernanke declared that his first crack at quantitative easing in the wake of the global financial meltdown, or what Fed watchers have dubbed QE1, worked. "Empirical evidence suggests that our previous program of securities purchases was successful in bringing down longer-term interest rates and thereby supporting the economic recovery."

The notion that QE1 did anything more than avert disaster is open to question. But that doesn't mean the Fed shouldn't try QE2, even if it's doomed to failure, says noted U.S. economist Allen Sinai, president of Decision Economics and an expert on monetary and tax policies.

Indeed, the Fed has no other cards left to play in its efforts to fulfill its dual mandate of ensuring price stability and maximizing sustainable growth. With short-term rates, the normal policy tool, already effectively at zero, the Fed is forced to become a direct player in the fixed-income market, buying up long-term Treasury bonds to bring down interest rates on mortgages and other longer-term debt.

Mere chatter about Fed intervention has already caused rates to fall.

Yet the central bank "could still be helpless, depending on what consumers, businesses and financial intermediaries do, independent of interest rates," Mr. Sinai says.

The problem is that the Fed can't possibly rescue the ailing U.S. economy on its own without effective fiscal, regulatory, trade and foreign exchange policies. And that prospect is exceedingly dim, given the inability of a bitterly divided Congress even to pass a budget before heading off on the midterm election trail.

"The monetary authority all alone should not be expected to address the kinds of problems that face the U.S. economy today," Mr. Sinai says. "Nevertheless, that's their job. They can't just sit around and do nothing."

He quickly amends that comment. "They could do that. There is a wait-it-out view, which is plausible: If we wait long enough, the private sector will respond and adjust on its own. … But that's not the nature of doctors. Doctors can't sit on their hands when they have a sick patient."

Mr. Sinai's own prescription calls for "out-of-the-box" thinking that would attack the critical problems simultaneously. The trick is to develop fiscal measures that would stimulate growth and boost jobs, but would also shrink the deficit as the economy recovers. Not surprisingly, he likens the process to a desperate quarterback throwing a hail-Mary touchdown pass in the last seconds of the game. And the odds of success seem just as long.

His preferred method is tax policy. Put simply, he would combine tax hikes and new levies that would have little impact on economic growth with tax cuts in areas that would do the most good. The new revenues would cover the cost of the reductions and keep the deficit from widening. For instance, he would eliminate the Bush tax cuts for the wealthy but keep them for everyone else; cut social security taxes; and, more controversially, impose a tax on stock market transactions. A value-added tax could be used to finance reductions in capital, business and personal income taxes.

But just because it makes sense doesn't mean any of it will come to pass in the poisoned political atmosphere of today's Washington. Which is why, at the end of the day, Helicopter Ben may well morph into Banana Ben (as some wags are prematurely calling him), presiding over the monetary affairs of the world's largest banana republic.

Investors need to take note of the global sea change, Mr. Sinai warns. "The handwriting's on the wall. This is a world of changed economic geography. Have-nots are now haves. Haves are now have-nots. Investors must reflect that in their own portfolios. Just as central banks around the world have diversified their foreign exchange reserves into other currencies and gold, so should investors, so they don't have all their eggs in the U.S.-dollar basket."