The Federal Reserve's Open Market Committee meets again today, and we suppose congratulations of a sort are in order. Last September, the committee declared that it wanted prices to rise more rapidly, and on that score it has succeeded. The question now is whether the Fed's success in promoting inflation is undermining the economic recovery it claims to be supporting.
This is the paradox of exceptionally easy monetary policy, and rarely has it been as obvious as it is today. The Fed has flooded the world with dollar liquidity that by its reckoning has lifted stock and other asset prices, eliminated the risk of deflation (if such a risk really existed), and prevented a double-dip recession. Wall Street and the White House are delighted.
On the other hand, this dollar flood has also contributed to a boom in commodity prices around the world, spurred inflation in countries with links to the dollar, and prompted investors to seek returns in non-dollar assets that are often risky and in many cases will prove to be a misallocation of capital. All of this, in turn, has reduced growth in real incomes, undermined consumer confidence and raised doubts about the durability of the recovery. The American middle class doesn't feel any richer.
Call this the price of putting all of your economic expansion hopes in Ben Bernanke's monetary basket.
The Fed Chairman still sees only the bright side, much as he did during the Fed's previous easy money binge in 2003-2005. "I think the increase in inflation will be transitory," Mr. Bernanke said earlier this month in Stone Mountain, Georgia, blaming high oil and food prices on "global supply and demand conditions." The Fed's sages assure us that the "core" rate of inflation that doesn't include food and energy is rising slowly, and that the oil problem will dissipate. As for inflation in the rest of the world, Mr. Bernanke says that's not his problem.
But it is already proving to be ours. Rising prices for raw materials and components are starting to flow through to U.S. goods. Kimberly-Clark, the consumer products maker, reported a sharp profit fall yesterday on rising costs and announced plans to raise prices on most of its North American products. Do Kleenex and Huggies qualify as core price increases?
The nearby chart shows the monthly increases in producer prices for finished goods since the Fed announced its second round of "quantitative easing" (QE2) last year.
The press is busy speculating about if and how the Fed will extricate itself from QE2, which clearly matters. But the larger problem is America's overreliance on the Fed as the driver of economic growth. With the failure of their stimulus spending plans, prominent Keynesian economists and pundits in particular have been flogging the Fed to do more. They seem to think Mr. Bernanke must save the dimming reputation of Obamanomics.
But the Fed has already kept interest rates close to zero for 28 months, purchased mortgage-backed securities and Treasurys at unprecedented levels, and blown out its balance sheet to $2.7 trillion. America hasn't run a monetary policy this loose in modern history. It was possible to justify such extreme measures at the height of the financial panic, but by now the recovery is nearly two years old. The expansion may be mediocre, but at least the economy is growing.
We too want faster economic growth, but the keys to that are fiscal and other reforms that would reverse the policies of the last four years. Much lower spending and tax reform, freer trade, fewer new regulations, an end to foreclosure mitigation and banker harassment, and repealing ObamaCare's job-killing taxes and mandates, among others.
Meanwhile, the longer the Fed keeps the dollar flood going, the greater the risks of serious economic harm. We aren't prescient enough to know what form that damage will take, but the danger signs are everywhere. In China, truckers are on strike to protest rising fees from that country's inflation. In the Middle East, food price increases add to the sense of injustice driving political protests.
And around the world, investors reach for investments—gold, silver, Iowa farmland, emerging market stocks—to hedge against the decline in the value of dollar assets or to bet on booming commodity prices. This dollar flood can't last forever, and when it stops the reckoning could be—for many it will be—harsh.
As for Mr. Bernanke's confidence that inflation will be transitory, we hope he's right. But we also recall his confidence in May 2007 when he declared that "Given the fundamental factors in place that should support the demand for housing, we believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited." We know how that turned out.
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