By Jerry Bowyer
Two of America’s great supply-side economists disagree. Brian Wesbury, a close friend and mentor of mine, believes that Fed policy is inflationary and that they should continue to raise rates. Larry Kudlow, also an acquaintance and mentor, believes the opposite. How shall we decide between them?
Let’s start with Abraham Lincoln, who once told the U.S. Congress that “Fluctuations in the value of currency are always injurious, and to reduce these fluctuations to the lowest possible point will always be a leading purpose in wise legislation.” In making this assertion, Lincoln positioned himself in the great tradition of classical economics which is now known as supply-side economics. Low tax rates are good for economic growth, and a currency value that does not fluctuate from year to year makes for economic growth without the uncertainty of wildly fluctuating prices.
The problem has always been how to decide when a currency is fluctuating in value. Supply-siders, as against other free-market types like the Austrians and monetarists, emphasize marketplace indicators of inflation and deflation. Supply-side economists tend to be practical people who are as often as not forecasters, investment advisors, and business consultants — as opposed to theoreticians. They recognize that it is simply impossible for any central planner to “count” the number of dollars in circulation. They therefore look to the financial markets — gold prices, interest rates, and foreign exchange rates — as the most reliable guides. If gold prices are flat (which they are this year), then currency speculators believe inflation is not on the horizon. If interest rates are low (as they currently are), then bond holders are not requiring higher interest rates, which they would be doing if they feared inflation. If the dollar is flat or rising against other stable world currencies (which it is), then foreign investors are not afraid that inflation will eat away their gains in dollar-denominated assets.
BuzzCharts strongly supported last year’s spate of tightening by the Federal Reserve when gold prices were signaling inflation. However, we recognize that the history of the Fed, as with most other central banks, is a history of overreaction. They almost always move in the right direction, but they do it late and for too long: In 2000 their excessive tightening led to a deflationary recession; after that, because they swallowed the establishment view that the Bush tax cuts hadn’t worked, they were excessively loose; currently, it appears to us, they may be in the danger of once again squeezing too much money out of the economy.
Nine rate hikes in a row may well have been called for, but we are beginning to believe that nine is enough.