Tuesday, May 15, 2007

To Raise or Not to Raise: That is the Question

This article by Thomas Kee over at Seeking Alpha raises some commentary in my brain.

[Thanks to Laurence Olivier and classics.www5.50megs.com for the image.]

He suggests that the Fed should raise rates now before wages start to rise, in sum nipping any core inflationary trend in the bud.

He notes, as I have also here recently, that the inflation figures are rising fast. In fact, today for the month of April the compounded annual seasonally adjusted rate has gone up two points from 4.7 to 6.7%. It will probably modulate, but these figures are alarming.

He wisely points out that even non-core prices, although more volatile, at some point become important to the pocket books of the citizenry; that these non-core prices, even though they may be subject to geopolitical concerns, can also sometimes be reacting to the same inflationary money-supply factors as core prices; and if this is the case, any sustained non-core inflationary price increases will at some point spill over into core prices. And he assumes they will. I agree, given the symptoms around us of a global bubble economy.

I would like to point out several things:

1. If the increases in non-core prices are due to geopolitical concerns, the increases should be ignored. At some point, things will readjust, or alternatives will be found. The Fed doesn't need to take any action whatsoever. In fact, any action merely adds another uncertainty to the game play.

2. If the increases are due to inflationary concerns, the cause for the increases should indeed be eliminated; but this should only happen when the economy can take it, and now is not the time. Today's tight labor market is putting pressure on salaries, which is actually a good thing, because it means that finally, the poor salaried worker is going to get the pay raise that he needs to cover the increase in prices. Let him get his pay raise. Don't raise rates now before he gets it, because you will just make a bad situation (higher prices) worse (diminishing real wages.) The poor guy is in the caboose of the inflationary train. Let him get up over the hill. Let him be compensated in just measure. Of course, non-core prices will rise; but this is just the natural denouement of the inflationary situation that already exists. Let it play out. And then, of course, most importantly, the Fed should in future refrain from instigating any measures whatsoever that inflate prices again, adding insult to injury. These measures are counterproductive. They distort the market pricing mechanism, destroy our dollar, and exacerbate economic inequality -- the very things the Fed is supposed to control.

3. At this point, assuming either (1) or (2), we are at a critical juncture in the business cycle, i.e. we are about to enter a contraction. (See my previous post.) The coming contraction, combined with high non-core prices, will be sufficient to control expansion. If the Fed tightens now, it will turn the contraction into a recession. To do so now will just deprive our poor worker of the raise he deserves and enrich the speculators whose profession it is to ride the roller coaster of business cycles. For these fellows, the wilder the ride the more they love the thrill, even if only a few reap the rewards (the lottery principle.)

So I disagree with Mr. Kee. The Fed should leave the rates where they are. (And of course they should definitely not lower rates, which they are also capable of doing at the slightest sign of business contraction, unfortunately.) At some point in the future, when the business cycle bottoms out naturally and when the economy starts to climb back up again, only at that point should the Fed adjust the rate so that it can remain permanent -- 5.5, 5.7, or whatever it is.

Then the Fed should put themselves on the back burner, only coming into action when there is a need for some reassurance -- and by action, I mean clearing house, short-term punctual self-eliminating measures, and jawboning. We don't need any more pumping up of the money supply, whether it be through interest rates or through purchases of treasuries.

Let the system handle the money supply. Put a few basic rules in place, i.e. reserve requirements, banking standards -- every banker knows what they are. (The gold standard would be nice, but I'm not living in a dream world.)

Central banks of the world, leave us alone. Stop playing roulette with the standard of living of the salaried worker, the small to medium business entrepreneur, and the emerging economies. You are killing us little by little, driving us towards government intervention and the death of the American experiment and of the US leadership role in the world.

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