Streetcar Line

Stop Bernanke’s Hanky-Panky

Raise rates, strengthen the dollar, now.

By 3.4.11

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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.

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About the Author
Quin Hillyer is a senior editor of The American Spectator and a senior fellow at the Center for Individual Freedom. Follow him on Twitter @QuinHillyer.