Does anyone really know what Alan Greenspan is up to? Does the Maestro himself know why the Fed’s target interest rate has been robotically raised eight consecutive times, with no end in sight? Is there a theory behind this money-tightening policy that can justify the threat it poses to future economic growth?
Take, for example, the latest monetary data from the Federal Reserve Bank of St. Louis. The data show a marked slowdown in key money-supply measures. The adjusted monetary base, over the past six months, is growing at a meager 2.6 percent annually. A broader money measure known as M2 has slipped to a below-normal 3.5 percent.
There may be two key reasons for this money slump. First, the Fed is injecting less and less new cash into the economy as it raises its short-term target rate. Second, the increase in short-term rates to 3 percent from 1 percent may be reducing future economic demand.
Every one of the monetary readings is now way below the 6 percent growth of current dollar GDP. While the fit between money and national income is a loose one, it is not irrelevant. It could be predicting a sub-par economy next year.
Instead of targeting inflation-sensitive, forward-looking market-price indicators — what supply-siders call adhering to a “price rule” — Keynesian fine-tuners at the Fed are up to their old tricks. It’s sort of like George W. Bush’s strategy for Social Security reform: When it comes to policy targets, everything is on the table for the central planners at the Fed. Vladimir Putin’s remaining Soviet-style bureaucrats have nothing on our money-meddlers in Washington.
It seems apparent that Greenspan is not targeting market-price indicators. So what is he targeting? Maybe he has the so-called housing bubble in his sights, or the mortgage credit-expansion behind it. If he is watching housing, he’s looking the wrong way. The key reason behind the surge in housing investment is the shower of tax advantages that have fallen on this sector since the 1997 tax bill. On a tax basis, it’s much better to invest in homes than in stocks as home-sale profits are tax-free up to $500,000.
One Wall Street investment manager asked me when the Fed is going to “fix” housing. I asked him, “Do you mean that Greenspan should get a ladder and a paint bucket and actually begin work on a house?” “No, no,” he said. “When will the Fed stop the bubble?” To which I responded, “That’s not the Fed’s job.”
There is a bubble in Naples, Florida. But there are no bubbles in Syracuse or Hartford. Or do the central planners at the Fed think their mandate extends to controlling the local economies of each and every American city?
In the last economic cycle the Fed ignored falling inflation and instead aimed its guns at the Internet bubble. We soon were reminded that any time you deflate the money supply, the overall economy slumps badly. Stocks delivered their worst performance in over 40 years. As for signs of inflation today, the price of metals and overall spot commodities are dropping, gold is going nowhere, and long-term bond yields are at 45-year lows. These tried-and-true inflation indicators are saying: “No inflation.”
So why do we need more Fed rate hikes?
The blowout jobs report for April, with 274,000 new business payrolls and an upward-revision of 93,000 for February and March, virtually assures that economic growth for the first half of 2005 will come in around 4 percent. The tax-cut led economy continues to be stronger than mainstream economists and the media would have us believe. But will the Fed attempt to limit this growth, as it has so often in the past, with its flawed economic models that mistakenly assume that more growth and more jobs are the cause of inflation? After all, how can more people working and producing cause inflation?
Milton Friedman taught us that inflation is a monetary problem caused by too much money chasing too few goods. However, as supply-side tax cuts expand the workforce, production, and investment, the increase in goods absorbs the existing money supply. Instead of prices rising, prices fall.
Former Federal Reserve governors Manley Johnson and Wayne Angell argue that financial and commodity-market indicators can inform the Fed whether money is too loose or too tight. Free-market prices, they’re saying, are smarter than central planners. Right now these market indicators, like the money-supply figures, are telling the Fed to stop tightening.
There’s a tug of war going on in the stock market today as the bulls and bears try to figure out which direction the future economy will go.
Does the Fed itself hold the answer?
— Larry Kudlow, NRO’s Economics Editor, is host of CNBC’s Kudlow & Company and author of the daily web blog, Kudlow’s Money Politic$.