Kudlow’s Money Politics

Is the Inner Bernanke Up to the Task?

All eyes are on the Fed meeting to see if the inner Ben Bernanke will lean toward inflation hawk Paul Volcker and follow through to stop inflation and defend — indeed recreate — King Dollar.

Volcker told us a few months ago that we were in a dollar crisis. Since then, Bernanke has been talking tough. No one expects a rate-hike announcement tomorrow at 2:15 p.m., but all eyes will be watching and reading the Fed policy statement to see if inflation is rated public-enemy number one. The artful term among Fed watchers is “inflation bias.”

Is inflation really a problem? Well of course sky-high oil and fuel prices make it thus. Check out today’s consumer confidence report: 12-month inflation expectations have skyrocketed to 7.7 percent! As recently as early 2003, that number was 4 percent — a rock-bottom reading that is seldom violated in these surveys.

And inflation is rising all over the world, especially for countries whose currencies are tied or shadowing the sinking U.S. dollar: China, India, South Korea, Thailand, Vietnam, Saudi Arabia, and Russia. Whenever the dollar sinks, global inflation is sure to follow. Even the strong-minded euro, piloted by inflation hawk Jean-Claude Trichet, has jumped to 3.7 percent from just over 1 percent a few years ago.

Many on Wall Street and in Washington say the Fed can’t tighten policy because the economy is weak. But you know what? The economy is weak in large part because of rising inflation, which is the cruelest tax of all. It diminishes corporate profits and family incomes. It also is forcing the unemployment rate higher.

Now the Phillips curve argues a tradeoff between unemployment and inflation. That Keynesian view is why all the Keynesian Wall Street and Washington economists are telling the Fed not to get tough. But check out some facts: The U.S. consumer price index bottomed in October 2006 at 1.3 percent. The unemployment rate bottomed six months later in March 2007 at 4.4 percent. Through May 2008, the latest readings have U.S. inflation at 4.2 percent and the unemployment rate at 5.5 percent. This is what we learned in the 1970s. Instead of moving in opposite directions, unemployment and inflation are moving up together. When you tax something you get less of it. By raising the inflation tax we are getting less job creation and higher unemployment.

This is not to say that the housing problem and the credit crunch haven’t weakened the economy. But it is to say that if the Fed can bring down inflation by taking back its easy-money rate cuts in the next 4 or 5 months, it will lower the inflation tax, resurrect King Dollar, and just maybe save the economy.

Is the inner Bernanke up to the task? We will soon know.

Larry Kudlow — Larry Kudlow is the author of JFK and the Reagan Revolution: A Secret History of American Prosperity, written with Brian Domitrovic.

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