It’s time to start hiking interest rates.
Just as the Fed did early in the previous decade, Fed
Chairman Ben Bernanke is artificially keeping interest rates too
low for too long, which could be baking hyper-inflation into the
monetary cake while weakening the currency so much that numerous
sources are
predicting the dollar soon will no longer be the
world’s “reserve” currency. If, as Milton Friedman said, “inflation
is always and everywhere a monetary phenomenon,” then we’re in for
trouble. In the year from January 2010 to January 2011, the M-1
grew by 10.3 percent and M-2 by 4.3 percent. The pace is
increasing. In the three months since October, M-1 grew at annual
rate of a whopping 15.6 percent.
Price hikes are occurring too. These aren’t all because of
monetary policy: Ethanol mandates are driving up food prices as
well, and political turmoil in the Mideast combined with President
Obama’s multitudinous efforts to stop domestic fossil-fuel
production are aiding the price hikes in oil and gasoline. But the
fact remains that only a weak housing market — housing costs are
weighted to count as more than a third of the Consumer Price Index
— is keeping the official measure of inflation as low as it is.
For owner-occupied housing, that’s an artificial means of
assessment: Mortgage costs haven’t fallen even as housing values
have dropped. But with food and oil and a huge spate of other
commodities all seeing rapid cost hikes, the average person is
feeling the pinch in his wallet even as the official index remains
low.
Literally halfway through writing this column, the latest
email arrived from the always-wise economist David Gitlitz,
blasting Bernanke: “The Fed chair didn’t do any better attempting
to explain the ongoing commodity price rally. The CRB spot
commodity price index is now at record high levels and has risen by
85% since the Fed began its first quantitative easing program two
years ago.” And: “At some point, the reality that inflation can no
longer be dismissed as a non-issue might become too obvious even
for Bernanke to ignore. That realization, however, is not likely to
come soon enough… to prevent the American economy from facing a
bout of substantially higher inflation.”
There’s a reason why gold has tripled in price in the past
few years: The dollar is as weak as it has ever been, and gold
buyers know that inflation is on the way.
Bernanke might think his zero-interest policies and weak
dollar will stimulate the economy, but it won’t. It’s not fear of a
hike in the discount rate to 1 or 2 percent (still remarkably low)
that is keeping investment on the sidelines; what is hindering the
economy is regulation, justifiable fear of out-of-control
regulatory enforcement, fear of exposure to a systemic collapse
caused by growing federal and state debts, and all sorts of other
predictable (and eminently rational) responses to the policies and
practices of the most leftist administration this country has ever
known. When inflation finally kicks in, then, it is likely to be
Carter-like stagflation, with the economy still relatively stagnant
even as prices go through the roof — because investors
still won’t want to invest, or consumers to spend, in the
face of such headwinds.
In the long run, monetary market manipulation by the
Federal Reserve is almost always a bad idea. On the other hand, if
the market has been over-manipulated in one direction, it might
make sense for the Fed to manipulate it for just a little while in
the other direction to make up for the error. Hence, while purists
might want to say it’s time for Bernanke just to let interest rates
float however they want to, without his hand really on the tiller,
it might instead be time for the Fed to actively push up interest
rates for just a while in order to re-establish the interest
market.
What is at play in this suggestion is the idea that
psychology plays a large role in economic decision-making. Here’s
how it works — at least at the extremely low interest rates in
play right now: First, with all of these other uncertainties and
bad policies weighing on them, businesses are perfectly content to
sit on the sidelines and see what happens. American corporations
right now are sitting on nearly $2 trillion in cash or cash
equivalents right now, rather than investing it. That $2 trillion
is a record, by a long shot. But if the people who run businesses
see interest rates start to creep up, and expect them to creep up
some more for a while to come, they might figure it’s time to
unleash their capital while the getting is still good. In other
words, if they want to make investments that require a combination
of capital expenditures and new borrowing (or expenditures backed
by credit of some sort), the thought of rising rates might make
them act now rather than later — because later in this case would
mean at higher rates.
This might be counter-intuitive, but it makes sense. It’s
like the oil Fram oil commercial: You can pay now when it’s cheap,
or pay later when it’s more expensive. In that case, you should pay
now — or, in this case, invest now. The corporate dollar
will buy more right now than it will later. For a little while at
least, then, slowly rising rates (combined with the expectation
that the Fed will keep hiking them at least for a little while)
will actually spur, rather than retard, economic activity.
More economic activity means more economic growth, which means more
tax revenues without higher rates, which means a better long-term
outlook for the dollar as well. And that, in turn, helps
avoid what few Americans realized would be an absolute nightmare
for us, which would be the loss of the dollar’s status as the
world’s reserve currency and the advantages that accrue for
Americans from that status.
Increasing signs of the Republican House’s seriousness
about budget discipline, and about rolling back regulatory excess,
will only increase the confidence of corporate leaders in the
relative semi-safety of bringing their money off the sidelines. If
adults are in charge, it’s more safe to play.
The Fed therefore needs to re-set the expectations game.
If it signals that the economy is strong enough to allow interest
rates to rise a little, investors will believe the economy
is strong enough — and therefore, by acting with more confidence
and investing more, they will actually make the economy stronger.
At least at first, it becomes sort of a self-fulfilling prophecy of
the right sort. That’s how psychology works.
None of this is to say that Bernanke should repeat the
idiocy of continuing to push up discount rates and the federal
funds rate month after month after month, as the Fed mistakenly did
in the mid-2000s. What is suggested here isn’t a major and lasting
artificial tightening, but only a temporary one. After that, the
market can take over very well, thank you very much.
Inflation and especially stagflation must be avoided. The
dollar must be strengthened. And the Fed must stop spooking the
markets by signaling that only the drastic action of keeping its
rates at zero can stave off another Great Depression. Confidence
begets confidence. So far, Bernanke has acted as if we all should
be running scared. He should reverse course now, before it really
is too late.
