Federal Reserve Bank of Philadelphia President Charles Plosser indicated that further interest rate reductions may be needed to stimulate the U.S. economy, should economic growth become "substantially weaker" than already projected, Bloomberg News reported Tuesday.

"A substantially weaker outlook than expected, particularly if that weakness is projected to be more prolonged than anticipated, may require further adjustments to policy,'' Plosser said in a speech in Gladwyne, Pennsylvania, adding that he already expects several ``sluggish'' quarters of growth, Bloomberg News reported.

However, Plosser also told Reuters that he's "concerned that developments on the inflation front will make the Fed's policy decisions more difficult in 2008."

The Fed's preferred measure of consumer prices has risen 2.2% on a November 2006-November 2007 basis, or at a rate above the Fed's comfort zone, leading many economists to argue that the Fed may not be as stimulative as it typically would be at this stage of the economic cycle. The Fed may also continue to use non-interest rate policy options to encourage economic activity, these economists say.

It's beginning to look like the Federal Reserve has lost its independence. However, rather than taking dictation from the White House, it appears to be under Wall Street's control.

Bloomberg News reports that the Fed is likely to cut interest rates when it meets this week. Traders in federal funds futures initially gave a 75% chance of a rate cut on October 31, but scaled back those odds to 50% after the October 5 revision of August payroll numbers to show a gain instead of a decline.

The reason the Fed stated for its September 18 50-basis-point cut made little sense to me -- some words about market turbulence. The market turbulence is real enough -- related to the subprime mortgage mess -- about which I posted here. But the Fed's job is to keep inflation in check -- and with oil prices hitting a record $93 a barrel and labor rates rising at a 4.9% annual rate -- it is surely failing at that job. (Save me the blather about core inflation -- and excluding energy and food prices.)

However, Bernanke is responding dutifully to his Wall Street masters -- using the interest rate cuts to ladle a heaping dollop of corporate welfare onto the gilt-edged plates of billionaire bankers and hedge fund grandees.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter.

I wrote yesterday about the recent Chinese veiled threat to dump its dollar holdings if the U.S. raises tariffs in hopes of coercing them to let the Yuan rise against the dollar. Today I had the opportunity to pick the brain of an expert on the topic, Brad Setser, Chief Economist at RGE Monitor and former acting director of the Office of International Monetary and Financial Policy at the U.S. Treasury.

My first question to him was, is this a credible threat? Setser didn't believe so, because it would represent a huge shift in China policy. The Chinese government, he explained, has shown a consistent bias toward supporting the country's exports, even at the cost of holding onto dollars as their value drops against other world currency. In fact, China continues to bolster its dollar holdings, adding $350-400 billion this year alone.

Setser went on to explain that, in his opinion, the Yuan was currently undervalued against the dollar by approximately 30%. If such an imbalance were abruptly corrected it would dramatically disrupt their export market.

He went on to say that China is in effect swallowing huge losses by holding dollars in order to support their exports, but the current regime has not indicated any likelihood to change that position.

However, he cautions, tensions between the two countries are growing, as the Chinese government takes umbrage at the growing movement in the U.S. to address the trade imbalance with legislation.

My take from this discussion: a change in the status quo is not in the offing, but the trade discussions in Congress are being watched carefully by the Chinese government. In the political season we are entering, pro-tariff campaign rhetoric could bring about more threats of reprisal.

Is our thirst for foreign capital about to bite us? According to a report in the U.K.'s Telegraph, officials of the Chinese government warn that they are prepared to dump their U.S. reserves onto the market should the U.S. government impose trade restrictions in an effort to persuade China to correct the Yuan/dollar imbalance.

China currently holds an estimated $900 billion in American bonds, and a total of $1.3 trillion worldwide. The warning is apparently a response to a bill backed by the Senate's Finance Committee that would impose tariffs to penalize China for currency manipulation.

This 'nuclear option', in the Telegraph's words, could be devastating to the already-weak dollar. However, as China's sugar daddy, such a blow to the U.S. economy would have vast repercussions on the Chinese economy as well. Any sane regime wouldn't take such a suicidal course of action.

So the question here, is one of sanity. Over the past decade, the Chinese leadership has shown many signs of economic savvy. One can only hope that the cooler heads prevail, and that this is simply brinksmanship aimed to carve out a better position in trade and monetary negotiations.

Analysis provided by Eric Buscemi of Theflyonthewall.com:

When Fed Chairman Bernanke took the helm of the Federal Reserve, it was refreshing to hear him say that the Fed would attempt to act more proactively. However, after hanging out with fellow board members, Bernanke is beginning to change his tune and sounds more and more like Alan Greenspan.

On Tuesday, Bernanke said policymakers want to see inflation continue to recede, suggesting the Fed probably won't be cutting interest rates any time soon. This means any proactive policy making decisions that he suggested when he took charge of the Fed will not occur.

Today, with massive amounts of top-down and bottom-up data to base decisions on, basing your decisions on inflation which is a lagging economic datapoint is just plain silly.

There is little evidence to suggest inflation is out of control and will not be decelerating during the next twelve months. Housing prices, oil, automobiles and everything technology-related will be cheaper in twelve months. The Fed Funds futures and the 10-year bond are all ready saying to start lowering rates.

Mr Bernanke, let's not act like Mr. Greenspan and act more proactively.