Influential billionaire supply sider Steve Forbes -- who long felt the Fed was too tight -- now says Fed is much too easy and we will see a big rise in inflation unless they tighten and soon.
Those who think rates will not rise much for a long time are in for a rude shock IMHO.
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Fact and Comment
Steve Forbes, 01.12.04, 12:00 AM ET
At Last, Good Times
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The economy has developed an impressive head of steam. Real growth in 2004 will be close to 5%, a sharp contrast to that of the past three years. The fundamentals are there for a great advance: extraordinary productivity; surging capital spending, including new investment in information technology; low inventories; job creation; and rising personal incomes. The tax rate cuts on capital gains, dividends and personal incomes passed in May last year are now providing a powerful stimulus. The Fed is stoking--nay, overstoking (see below)--the monetary fires.
Of course, some hideous terrorist attack here or some stunning international blowup on the Korean Peninsula or elsewhere would quickly dampen this optimism. Barring such a disaster, however, we're in for some giddy growth.
Alas, a Serpent Lurks in this Garden of Growth
Most observers play down the possibility of resurgent inflation: There is still plenty of unused capacity in the economy; productivity is remarkably high; labor costs remain reasonable; and price-pressuring competition from India and China is intensifying.
The fundamentals these experts cite are valid, but inflation is a monetary phenomenon, period. They are making a crucial mistake in confusing price changes resulting from fluctuations in supply-and-demand and productivity with price changes that come about from a debasing of the currency. If a central bank creates too much credit, the nominal cost of money eventually rises and investment patterns are skewed. The 1970s painfully demonstrated that you can simultaneously have rising prices and economic stagnation. Inflation puts a premium on hard as well as existing assets. It is the enemy of innovation: Startup companies and inventions were starved of development capital during the 1970s.
Make no mistake; the Federal Reserve is inflating. Think of the economy as an automobile engine. Our central bank has lurched from stalling the engine by supplying insufficient fuel--as it did from 1997 to 2001--to flooding it with excessive fuel. Politically, the repercussions won't be felt until after this year's elections, as the full impact of a monetary mistake isn't experienced for 12 to 18 months.
However, the telltale signs of excess are already present. The amount of money the Fed directly creates through the buying of bonds in the open market--the measure called M1--has ballooned (see chart, above). Commodity prices have soared. The price of oil, for instance, is running above $30 a barrel, and OPEC is beginning to make noises about manipulating prices, à la the 1970s. The best barometer of monetary disturbance is gold. Its average price in the last decade was about $330 an ounce. Now it's more than $400 an ounce. The longer the price remains that high, the more trouble we'll have down the road. The optimum price is around $350 to $360 an ounce. Another sign of trouble is the current large gap between short-term and long-term interest rates. What about measures of inflation, such as the Consumer Price Index, that are negative? These indexes are lagging indicators. They tell us the past; they don't forecast the future.
The Fed can easily correct its overshoot. Sure, short-term interest rates will go up, but the markets will heave a sigh of relief if we signal that we're not going to let the situation get out of hand. Long-term rates will remain steady, or may even come down a tad.
What will get Greenspan & Co. to act? Sooner rather than later the foreign-exchange markets will put our government to the test by launching a full-scale attack on the greenback. The Federal Reserve is dreaming if it thinks it can hold off remedial action for its inflationary miscalculation until after November. |
