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.
The Chicken Littles: At the moment these guys are, to mix my metaphors, in the catbird seat. They dominate the financial newsprint and the punditocracy, although consistency is not their strong suit. Sometimes they say we’re heading toward high inflation, but at the same time they maintain we’re in the throes of a huge housing-price drop (which would be deflationary). They worry about the dollar falling while they sweat over rising imports (even though falling dollars are supposed to cut imports). They say people have too much debt (which they call “leverage”) and then worry that the “negative wealth effect” of a housing slump will cause people to stop spending as much. They worry one day that the mortgage industry says “yes” too often (leading to more sub-prime worries) and the next that the mortgage industry says “no” too often (darkening the outlook for the homebuilding sector). They’re stuck on a permanent loop of doom that’s built of varying and often contradictory rationales.
The Vultures: These are the smart-money folks. They probably don’t like being called “vultures,” and you can call them “opportunistic investors” if you like. I call them, well, when I need to borrow money . . . (Kidding.)
The vultures see the gap between the lay of the land and what the Littles are saying, and they buy the difference. The most important thing I recently learned about sub-prime mortgages is that Wilbur Ross is buying into them. (Full disclosure, I privatized an airport with Mr. Ross in the mid-1990s. I was on the government side and he was with Rothschild Bank.) Hedge funds are lining up to buy Northern Rock, and Countrywide popped in price big-time last week. Meaningful? Yes. When people who don’t know their Alt-A’s from their control-alt-deletes are waxing eloquent about the dangers of the mortgage markets, billionaires are quietly buying.
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So there’s my new filing system. I don’t want to egg anybody on, but I welcome continuing comments from all species. Send them by owl or carrier pigeon, but be patient; this is not the kind of issue that can be settled in one fell swoop.