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Monday, April 28, 2008

Bashing the Fed … and Rightly So

There’s a lot of bad economics being spread in the media and by assorted economists and analysts when it comes to inflation. Unfortunately, this is nothing new. Of course, one kind of hoped that as time passes, some economic lessons might have been learned. But alas that seems not to be the case.

Fortunately, The Wall Street Journal editorial page gets it on economics, including the source of and remedy for inflation. It is well worth reading the paper’s lead editorial on April 28 titled “The Fed’s Bender.”

A few key points are worth highlighting here:

• “Eight months into the Fed's most recent rate-cutting spree, the evidence is overwhelming that it has been a major policy mistake. Aggressive rate cutting – taking the fed funds rate to 2.25% from 5.25% last September – has had little effect on the banking crisis it was supposed to ease.”

• “Meanwhile, the Fed's decision to open the general monetary spigots has inspired a global commodity boom unlike any since the 1970s. Oil has climbed to nearly $119 a barrel today from $70 in late August, a 70% increase. Farm and other commodities have seen a similar surge, with corresponding increases in food prices leading to shortages and riots in Egypt and other places, and to rice hoarding even in Southern California. The popular media explanation is that this price surge is a result of rising global demand, greedy speculators and human profligacy. All of a sudden, without warning, the world is said to be running out of food. After 30 years in intellectual hibernation, Thomas Malthus and the Age of Scarcity are back in style. No doubt commodity traders are having a field day, but what they are speculating on is the Fed's refusal to stop the free-fall of the dollar. The weak dollar has created another speculative bubble, this time in commodities.”

• “As for the intellectual problem, the Fed and much of Wall Street convinced themselves that the only inflation measure that matters is ‘core inflation,’ which excludes food and energy. The Fed's monks devised that measure to avoid an overreaction to commodity price movements, but instead they have used it to pretend that food and energy prices don't matter. Throughout this decade, they pointed to core inflation to argue that ‘inflationary expectations remain well anchored,’ even as the dollar and commodity price signals were telling us that the opposite was true. Americans don't buy gas and groceries with ‘core’ dollars.”

This article is right on target, and required reading if you really want to understand what’s been going on with the Fed, the economy, the dollar and inflation.

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