Brace for Dollar Inflation

The Wall Street Journal editorial board has been cautioning the Fed on its loose money policies for some time now.  Two recent op-ed’s step up the warning.

The Federal Reserve has only one lever to push: the short-term lending rate for dollars, which affect the “supply of money.”  Ideally it would only use that lever to control one thing: inflation.  However, as Ben Steil explains, economics are complicated and the effects of interest rate changes on inflation can be delayed and indirect.  So the Fed has allowed itself to consider questions like employment, GDP, and market conditions when setting its rate.

For example, with credit and liquidity crises racking the markets the Fed has dropped its rate perilously low even as inflation has hit dangerous highs.  The Fed argues that it can solve the market crisis and that the current recession will deal with inflation before long.  So far the Fed has gotten away with this — markets are still pricing in an expectation of nominal long-term dollar inflation — presumably thanks to the credibility the Fed has banked since the early 1980s.  I.e., people still believe that the Fed will finally make the hard call to raise rates if the recession doesn’t pull us back from the brink of inflation.

Gerald O’Driscoll (“Washington Is Quietly Repudiating Its Debts“) doubts this can continue.  The presence of political pressure in the Fed’s calculus should give us pause.  The U.S. government is piling on obligations: Debt spending, unsustainable entitlements, and now government bailouts of market makers.  It will be increasingly difficult for government to resist the temptation to inflate its way out of its debt — certainly not while the Fed is willing to subjugate a stable dollar to concerns of market strength or shorter-term financial stability.

A stable currency is a tremendous boon to market efficiency and general welfare.  Large or unexpected inflation takes money from creditors and transfers it to debtors, with bad results for the overall economy.  Fortunately, it is possible to limit one’s exposure to the risk of excess inflation, as I suggested earlier.  This is a good time to increase your hedges against dollar inflation.

8 thoughts on “Brace for Dollar Inflation

  1. Many are arguing that in the short term (a few quarters) deflation concerns and a flight-to-safety will actually drive treasury yields down before real inflation and overborrowing by the government finally cause yields to shoot up.

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