Editor's note: this piece originally appeared on the National Review Online.
My e-mail inbox is usually near full these days. That’s what happens when people are confused about the markets. But necessity, as they say, is the mother of invention, and I’ve used this deluge to improve my computer filing system. Rather then let my e-mails stack up on top of each other, I now place them in specially marked folders, according to their economic species. Herewith, my folder headings and cataloguing criteria:
The Hawks (inflation hawks, that is): These folks believe the Fed is pumping too much money into the economy and that it should have raised the fed funds rate a long time ago, at least to 6 percent. We’re about to enter an inflation meltdown, they tell me. “Just look at the gold price.” The problem with this view is the timing.
The chart above describes how the Fed was at its loosest four years ago. One year later, once that money worked its way through the system, voilà: Inflation peaked. It’s been mostly downhill since then.
If the inflation hawks are right and the fed funds rate should be at 6 percent, they must have been in hawk heaven during August’s credit crunch. For one brief shining moment interest rates soared and the stock market tumbled. Fortunately, the Fed recognized the money shortage and opened the monetary spigots. Markets improved.
I will here note that many inflation hawks are on the supply-side of the ledger, and that some are among the smartest forecasters in the business today. I disagree with them only sometimes, and I always worry when I do.
The Doves (inflation doves, that is): Members of this group note that there was in fact significant inflation after the Fed’s money flood in 2003, as would be expected, but that the excess money was soon absorbed in a growing economy. The views of the doves seem to fit reality best, although there’s a danger of complacency. For instance, the Bush administration has a history of flirting with attempts to weaken the dollar. The fact that we don’t have much inflation is no reason to get so confident that we can risk a run on the dollar on which billions of people depend.
Larry Kudlow uses the evocative phrase “king dollar.” And while the king doesn’t need to be propped up by excessively tight money, neither should he be unceremoniously shoved off of his throne by protectionist China bashers, inside or outside the government.