Memo To: Federal Reserve Policymakers
From: Jude Wanniski
Re: Warning Alan Greenspan!!
Last June 30, Alan Greenspan and the Federal Reserve's Open Market Committee decided to begin raising interest rates to combat an inflation they saw coming just around the corner. The day before, the Washington Times ran an op-ed that I co-authored with Jamie Galbraith of the University of Texas, urging the Fed NOT to raise rates. My position in letters to my clients has been that purposely slowing the economy would, if anything, reduce the demand for dollar liquidity and cause an inflation that scarcely existed last June. In the nine months since, the Fed has raised interest rates seven times by a quarter-point each time. The overnight rate is now 2.75%, up from 1% when it began. In its meeting last week, the Fed announced that inflation is now breathing down our necks, suggesting it might have to raise rates faster and in bigger amounts!! Yikes!!
The reason I'm apologizing to Dave Ranson, a fellow supply-sider, is that I have been telling clients that Polyconomics has been virtually alone in arguing against the Fed rate hikes. For some reason I'd never seen Dave's op-ed in Barron's last June 28, but someone sent it to me the other day and son-of-a-gun, he was "on the money." I'm posting his piece, which is just as much "on the margin" today as it was back then -- only now the Fed is threatening to make matters even worse. Please send this to your congressperson and remind him/her that the Constitution empowers the Congress to manage the money. It is in "Section 8, Clause 5: To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures."
* * * * *
The Fed's Futile Gesture
Why raising rates won't curb inflation
By David Ranson
June 28, 2004
WHEN THE FEDERAL OPEN MARKET Committee meets Tuesday, it is universally expected to raise the federal-funds rate by a quarter of a percentage point in an effort to curb inflation. But the Fed's prospective action is so far behind the curve in catching runaway prices, the gesture will be futile. Worse, higher interest rates not only are unlikely to restrain rising prices, but if forced up as rapidly as they came down in 2001, will lead to another recession, the very opposite of the central bank's expressed goal of "maximum sustainable economic growth."
The Fed - and the U.S. Treasury - instead need to turn their attention to the dollar, whose depreciation has resulted in higher prices on a broad range of goods. From gold to gasoline, higher commodities prices indicate that inflation, about which the Fed only lately has expressed concern, already is beyond its control. The clock cannot be turned back, especially through interest-rate increases, since using monetary policy to stifle the fledgling economic recovery would only make matters worse. It is time to think outside the proverbial box.
What has thrown us off the rails is the widespread misconception, especially in Washington, that inflation is something that happens only to consumers - that is, voters. Price increases elsewhere in the economy's long chain of distribution are paid little attention, save for the producer-price index, which sometimes is recognized as a leading indicator of consumer prices.
Inflation occurs whenever the value of money deteriorates. Price signals show up most quickly and reliably in markets that are efficient (close to perfect, in fact), such as those for commodities and raw materials. The products in these markets are virtually homogeneous; their price changes can't be disguised. Moreover, arbitrage, often on a worldwide scale, forces quoted prices into conformity with economic forces, more or less instantly.
From a market perspective, inflation occurs as soon as the dollar broadly loses purchasing power in commodity markets. The best commodities to watch are those, such as gold, that have proved to be stable benchmarks of purchasing power over centuries. In the past year, gold has rallied almost 15%, to an April 1 high of $427.25 per troy ounce, and now sells for about $400.
Where products are multifaceted, markets are imperfect and the measurement of prices is far more complex. In most consumer markets, products are ill-defined, and arbitrage is not feasible. Quoted prices might be inflexible, but variations in quality, delivery and associated services occur regularly.
In a sense, inflation goes underground, and deteriorations in purchasing power often are hard to detect. At the least, most are missed by the government's price statisticians.
But the disappearance of discounts at the shop counter, the growth of discount retailers, and the selection of cheaper substitutes on the part of consumers are all telling signs. Although the quoted prices of many products might stay unchanged for a time (and most often do), if the true value of what is delivered to the consumer slips, that's just inflation in another guise.
Fed Chairman Alan Greenspan is said to set great store on "cost pressures" in the labor market. A bad choice, that. It's even more difficult to recognize and measure inflation in such an imperfect market, where wages and salaries are set by contract, explicitly or implicitly.
The true price of labor changes any time employers get less or more value for the wages they pay, but there's not much chance of accurately measuring that. Such variations occur all the time, and usually have nothing to do with the nominal wage. In any case, it's no secret that labor-cost data are even longer-lagging indices of inflation than the CPI.
The Fed now is in the position of trying to bolt the door after the horse has left the barn. It didn't see the horse heading for the door in advance, because it focuses almost exclusively on the behavior of official consumer-price and wage data - that is, on inflexible and lagging indicators. These might be capable of registering how much inflation was in the system in the past few years, but they have nothing to say about how much is in the system now, or is likely to be in the future.
Long ago, Greenspan himself advocated using the commodities markets as a forward-looking economic indicator. It's unfortunate that he has gone back into the box, and succumbed to the myopia inside the Beltway, now that he is in a position to act on such vital insights.
DAVID RANSON is president and head of research at H.C. Wainright & Co. Economics, South Hamilton, Mass.