Bernanke should be raising rates

The sky is falling, according to Ben Bernanke. We are in the throes of a financial crisis! Hurry lower rates before it spreads and we have a full blown depression!


Yes the economy is slowing, there is no denying that. The housing debacle in the United States has reduced (or eliminated) people's equity in their homes, and that has left them feeling less wealthy. Also construction, which was a big part of the nation's economic recovery after the 9/11 terrrorist attacks, has slowed dramatically. This has of course led to job losses in that sector, and we've also lost much of the huge spending that comes with large construction projects.


There are some bright spots, however. The weak dollar has pumped up exports and the trade defecit has declined. It is amazing for all the talk of the trade defecit and protectionist measures, nobody talked about the obvious problem, that the dollar was simply too strong. Now if we can just get China to allow their currency to be valued fairly by the market we could make some real progress with the defecit... Due to the weak dollar earnings across most sectors of the economy not related to housing have remained remarkably resilient. In fact before the 1990's procolamation of a "new economy" the current unemployment rate would be considered dangerously low and inflationary.


Which brings us really to the broader problem, that most Americans don't want to accept. Free markets do ultimately produce the most efficient result, but the cost of that efficiency is fluctuation. In order to discover the most efficient way to do things, businesses have to try new things. Sometimes they make mistakes. Mistakes cause fluctuation, in the form of job losses, slower growth, inflation, etc. Ultimately however the businesses learn from their mistakes, implenting what worked and getting rid of what didn't. This process ultimately leaves us stronger and more efficient (thus more wealthy) than when we started. But in order to get there you have to endure some fluctuation, and pain, which people of course understandably dislike. But it is part of the process that we have to accept. Business cycles are always going to occur, and we have to allow them play out.


Bernanke's primary concern right now should be inflation. Oil prices get all the attention, but due to increasing affluence in the world (especially in China and India) and partly because of our ill-conceived subsidies and love affair with corn based ethanol, food prices are also skyrocketing. It is hard to ignore that the price of almost everything much higher than it was a few years ago. This represents a much larger danger to the economy than unfolding of the current business cycle.

What would happen if Bernanke raised rates? First the bubble in oil prices would pop. Yes oil is going to remain high regardless, but it currently prices much higher than it needs to be. Supplies remain abundant, the market is engaging in pure speculation. Prices did come down briefly, but due to Bernanke's rate cuts the market now is speculating that the US may avoid recession. Bernanke's cuts have also weakened the dollar, which has also put upward pressure on prices. Rate increases by the Fed would finally pop the housing market bubble. Yes prices are coming down, but they have much further to go. An increase would accelerate the decline to true market levels, which would finally stimulate demand and help us get rid of all this excess inventory. Of course we would endure some pain during the process. But that pain has to be endured. We can either get it over with and bring prices under control and move back to a period of prosperity, or we can go through a prolonged period of stagnation and rising prices.


The fed mercilessly raised rates in the early 80's to bring inflation under control despite the economic pain it caused in the short term. But it led to almost 20 years of unparalleled prosperity. It's a lesson that should not be forgotten.