SO the Federal Reserve Board’s monetary policy committee (technically, the Federal Open Market Committee, or FOMC) has decided to leave interest rates as they are - which is far less important than how it arrived at that decision. What follows is a combination of hard fact and my own surmise, mixed together so as to shield the usual highly placed, reliable source.

There is something called “the Fed family”. It’s not as shady as a mafia family, but far more powerful. Members include chairman Ben Bernanke and the six other members of the board of governors, appointed by the president; the presidents of the 12 regional Fed banks, five of whom serve on the FOMC; and several influential alumni who are frequently consulted by Bernanke and the White House, and whose public utterances Bernanke cannot ignore.

In times like these - when recession looms, inflationary pressures are rising, and a lot of banks are, er, teeter-tottering - many of the family members weigh the several dangers differently. Some worry about rising unemployment, and want to keep interest rates low. Some worry more about inflation, and want to raise rates. Others worry about the health - or lack of it - of the banks, and favour the sort of open-handed policy that Bernanke has adopted to provide liquidity to the banks. Still others worry that bank bail-outs will create the moral hazard that the Bank of England’s Mervyn King so fears, and produce even more reckless lending behaviour. Gone are the good old days when benign economic conditions led to virtual unanimity of views.

So far, so obvious. But two things are not so obvious. The first is the intensity of the battle within the Fed family. That has an advantage: Bernanke benefits from a wide range of views, which he says he welcomes. The board of governors generally worries most about the soundness of the banking system. The presidents of the regional banks, selected by local businessmen and bankers, generally worry more about inflation than anything else, which is why the presidents of five Fed regional banks have opposed recent rate cuts. The members of the FOMC worry about everything. And the alumni sit on the sidelines, rather like inlaws, sniping or supporting the chairman, depending on their view of each of his actions. Not a bad system, even if it is a bit messy.

Enter Treasury secretary Hank Paulson, the Saudis, and the White House. Someone has to find customers for the billions in Treasury IOUs that result from our ongoing federal budget deficits. That’s Paulson’s job, making him the nation’s No 1 bond salesman. The Saudis are among his most important customers. But the decline in the value of the dollar is steadily reducing the value of the dollar-denominated bonds they hold. So Paulson decided to go to Riyadh late last month to soothe some ruffled royal feathers. Reliable sources say that the Saudis “hinted, as is their style” that if America wants more oil, it should do something to shore up the dollar. Not unreasonable: the falling dollar reduces the purchasing power of the bits of paper the world uses to pay for oil.

Paulson brought that message back, got President George Bush and Vice-President Dick Cheney to agree, and started talking up the dollar. Independently, or perhaps not so independently, Bernanke let drop a clue that further interest-rate cuts are not now on the cards. As the Left is wont to say, it is no coincidence that the Saudis followed by announcing several increases in oil production.

But the story doesn’t end there. Higher interest rates not only boost the dollar, they make it more expensive for the banks to raise the new capital they desperately need. Bank shares plummeted. The members of the Fed family who worry most about the stability of the banking system saw meltdown in America’s future if all this talk of interest-rate increases persisted. Timothy Geithner, as president of the New York Fed the man closest to financial markets, undoubtedly pressed for an end to all this talk of raising interest rates.

So here we are. Paulson, with the backing of Bush, pacified the Saudis by promising to support the dollar. He could have done that by direct intervention in the currency markets - a power possessed by the Treasury, not the Fed. But Paulson probably knows that such interventions rarely succeed in “fighting the market”, and so confined himself to jaw-boning.

In return for talking up the dollar, and putting an added strain on the banking system, he got a bit more oil, mostly of the sour, heavy sort for which there is no available refining capacity. The Fed had to make sure that things did not go from bad to worse for the banks, even if that meant not hinting at the dollar-boosting interest-rate increase that the Saudis are looking for. So in last week’s statement the FOMC indicated that it is worried about inflation, but “expects inflation to moderate later this year and next year”. No interest-rate increase needed, at least unless the inflation indicators head towards the sky.

The ball is back in Paulson’s court. He has to decide whether his commitment to the Saudis now requires him to start buying dollars to prevent a further decline in the greenback. Or he could try to persuade his royal customers, who kept their end of the bargain, that merely by threatening intervention he was strengthening the dollar.

This is the stuff of which good novels are made. But it is not fiction. The Saudis have now extended their influence over oil prices to American monetary policy. If another reason for America’s politicians to end what Bush calls the nation’s addiction to oil is needed, surely this is it.

Irwin Stelzer is a business adviser and director of economic policy studies at the Hudson Institute

Times Recommends

• Lies and cover-up at MG Rover exposed by report
• High oil prices push manufacturing costs up
• Primark founder steps down as chief executive