Good ad­vice from a lone sup­ply sider

The Washington Times Weekly - - Commentary -

At­ten­dees of the G-20 meet­ing in Pittsburgh and mem­bers of the Fed­eral Re­serve Board in Wash­ing­ton should care­fully read a Wall Street Jour­nal oped by Fed Gov­er­nor Kevin Warsh. In a piece ti­tled “The Fed’s Job Is Only Half Over,” the for­mer Wall Street in­vest­ment banker sends a shot across the global eco­nomic bow. He says the Fed’s job will not be done un­til it re­moves the easy­money poli­cies put in place over the past year. In other words, an exit strat­egy.

Mr. Warsh writes that “pol­icy likely will need to be­gin nor­mal­iza­tion be­fore it is ob­vi­ous that it is nec­es­sary, pos­si­bly with greater force than is cus­tom­ary.” He’s say­ing the Fed must be tougher, and act sooner, if it is to avoid an in­fla­tion­ary bub­ble rem­i­nis­cent of the 2002-06 pe­riod, or for that mat­ter the 1970s.

Ap­pointed by Pres­i­dent Ge­orge W. Bush in 2006, Mr. Warsh may be the only real sup­ply-sider at the cen­tral bank. And while he doesn’t ex­plic­itly talk about the prof­li­gate surge of fis­cal spending and bor­row­ing by the Obama ad­min­is­tra­tion and its in­ter­na­tional coun­ter­parts, it’s not hard to in­fer that he’s talk­ing about that, as well.

But back to mon­e­tary pol­icy. Mr. Warsh says the Fed should not ob­sess about back­ward­look­ing in­di­ca­tors, like gross do­mes­tic prod­uct and yes­ter­day’s inflation read­ings. In­stead, he ar­gues that the cen­tral bank should track for­ward-looking signs of growth and inflation by pay­ing care­ful at­ten­tion to fi­nan­cial mar­kets, as­set prices and risk pre­mi­ums.

In essence, Mr. Warsh is opt­ing for a mar­ket-price rule that pre­sum­ably tracks com­modi­ties (in­clud­ing gold), bond mar­kets, the dol­lar ex­change rate and var­i­ous credit-risk spreads in the fixed-in­come area. He’s mov­ing away from the Philips Curve and the idea that the Fed should tar­get an un­em­ploy­ment-inflation trade­off — which is all Ben Ber­nanke ever seems to talk about.

Since the un­em­ploy­ment rate is a hope­lessly lag­ging in­di­ca­tor, the inflation forces will be well out of the barn by the time it starts drop­ping sig­nif­i­cantly. But Mr. Warsh knows that mar­kets flash signs of the fu­ture. So rather than drive by watch­ing the rearview mir­ror, he wants the cen­tral bank to look through the front wind­shield.

Mr. Warsh was a se­nior White House of­fi­cial un­der Pres­i­dent Bush, and he had a hand in the sup­ply-side tax cuts on in­vest­ment that were en­acted in 2003. But it sounds like he learned a lot about the Fed’s cheap-money poli­cies at the time. Those poli­cies drove down the dol­lar for years and res­ur­rected inflation, and they’re what killed the in­cen­tive ef­fects of the Bush tax cuts and their pos­i­tive ef­fects on eco­nomic growth.

The sub­se­quent hous­ing and com­mod­ity bub­bles — in­clud­ing the mas­sive en­ergy shock — ut­terly doomed the econ­omy. The Fed took tiny, one-quar­terof-a-point steps over a pe­riod of four years in an at­tempt to re­claim anti-inflation nor­malcy. But the pol­icy failed dis­mally. So now Mr. Warsh seems to be say­ing: Let’s not make the same mis­take again. Let’s take strong, large steps to raise the tar­get rate and drain ex­cess cash from the econ­omy.

I’m will­ing to bet that the rise in gold and com­mod­ity prices, along with the drop of the dol­lar, has Mr. Warsh think­ing the Fed’s tight­en­ing time is not far off.

Of course, this same dol­lar tur­bu­lence should be a ful­crum for the G-20 na­tions. If the U.S. green­back keeps sink­ing, a mon­key wrench will be thrown into the global re­cov­ery. Dol­lar de­pre­ci­a­tion can ex­port U.S. inflation world­wide, and drive up in­ter­est rates at home and abroad, if we force our trad­ing part­ners to print too much money by buy­ing too many dol­lars in a fu­tile at­tempt to ab­sorb dol­lar-ex­cess.

So in­stead of bash­ing banker pay, the G-20 mem­bers should un­der­take a world­wide dol­lar­res­cue-and-sta­bi­liza­tion pro­gram. That would strike a blow for cur­rency sta­bil­ity ev­ery­where and pro­mote global eco­nomic growth.

Alas, I don’t see any growth poli­cies com­ing out of the G-20 na­tions right now. And with phrases like “peer re­view” be­ing thrown around, I fear a U.S. ex­er­cise in fi­nan­cial and eco­nomic mul­ti­lit­er­al­ism. Just as Pres­i­dent Obama seems to sug­gest that Amer­i­can for­eign pol­icy will be run through the United Na­tions, I’m won­der­ing if U.S. eco­nomic and fi­nan­cial poli­cies will be passed through the G-20 — a one-world fi­nan­cial reg­u­la­tor that will hand­cuff the Amer­i­can sys­tem.

At the mo­ment there are no sup­ply-side tax cuts on the ta­ble. There’s no clear trade lib­er­al­iza­tion. And there’s no fo­cused at­ten­tion on the cur­rency prob­lem known as the dol­lar. Brazil and China are talk­ing about a new world re­serve cur­rency, which is one rea­son why gold has been ris­ing. But the dol­lar dilemma will rein supreme un­less the G-20 does some­thing about it.

Kevin Warsh doesn’t go this far in his Jour­nal piece, but his at­ten­tion to fi­nan­cial-mar­ket price sig­nals is some­thing all the big-shots in Pittsburgh should be think­ing about.

Lawrence Kud­low is a na­tion­ally syndicated colum­nist.

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