Had enough of high prices?
Of all the bad economic data, the cost of food and oil need the Fed's urgent attention.
As they started their election face-off last week, John McCain and Barack Obama were reminded why the economy is the hot topic. On Friday alone, oil prices jumped 8 percent while the Dow fell 3 percent. Unemployment in May saw the largest jump in 22 years. And inflation? It's near 4 percent a year, driven by higher food and gas prices.Skip to next paragraph
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This salad bowl of sudden bad news makes it all the more difficult to choose the best action. Which battle should be fought first – economic downturn or a price upturn? The tools for each are different.
During a presidential campaign, the more popular course would be to give short-term help to consumers, such as extending jobless benefits or sending out another round of stimulus checks. Such recycling of tax revenues back into people's pockets may meet the immediate needs of millions (and win votes). But the macro effect is minimal. The political campaign should really debate the greatest economic threat, the one that touches everyone and can last for long stretches if it isn't nipped early: inflation.
That debate has largely been confined so far to the Federal Reserve, whose leaders appear to differ on when to start raising interest rates in order to beat back rising inflation. Since September, as the housing and credit crisis has hit hard, the Fed has driven down rates to 2 percent, from 5.25 percent, with an eye on easier borrowing and preventing recession.
But a few unexpected wasps have landed in that ointment.
Home mortgage rates haven't dropped much because lenders foresee more inflation in their telescopes. Prices for food alone are rising at an annual rate of 9 percent, driven in part by misguided subsidies for corn ethanol.
And oil prices? They continue to defy gravity, rising more than 40 percent so far this year.
To global investors, prospects of unchecked US inflation make the dollar look very unattractive – it's lost a quarter of its value since 2002. Where do investors go? To commodities such as oil, raising prices again and adding to inflation. Compounding oil's prices was an implied threat last week by a top Israeli official who said an attack on Iran's nuclear weapons program is "unavoidable." With Iran as OPEC's second-largest oil exporter, a war there would push prices to unbearable heights.
Europe has it right. Its central bank puts inflation as the top priority. It hints of higher rates next month. Meanwhile, the Fed chairman, Ben Bernanke, merely says he is "attentive" to the effects of a weak greenback on inflation. He needs to back up words with action and hike interest rates quickly to draw investors to the dollar.
The Fed under Alan Greenspan held down rates too long in 2003 in response to a recession, helping create the housing bubble. Mr. Bernanke should now listen to Richard Fisher, president of the Dallas Fed, who says he hopes for a change in monetary policy soon: "Inflation is the most insidious enemy of capitalism. No central banker can countenance it, least of all the men and women of the Federal Reserve."
The US economy has enough underlying strength to bear the burden of higher interest rates. Without them, the US will only lose its strength in the long term if high inflation takes hold.