YOU DON'T HAVE TO BE A CHINESE CENTRAL BANKER with a vault full of greenbacks to feel queasy about the soaring U.S. deficit and the consequent risks of inflation. Worry warts are breaking out all over. They are sounding the alarm in stock letters, at press conferences, and within the marbled halls of the Federal Reserve itself. In fact, recent speeches by Charles Plosser, president of the Federal Reserve Bank of Philadelphia, and James Bullard, president of the Federal Reserve Bank of St. Louis, are so similar that there appears to be an orchestrated attack on the inflation policies of Federal Reserve Board Chairman Ben Bernanke.
"It sounds like they are telling Bernanke that we have to start worrying about inflation right now," says economist Robert Auerbach, a professor at the Lyndon B. Johnson School of Public Affairs at the University of Texas at Austin.
Plosser has been an advocate of inflation targeting for years, but in recent months he's turned up the volume. In an Oct. 20 speech at Stanford University, he suggested that the Fed adopt an explicit inflation target. He made the same suggestion in speeches in May, February, and January.
"This can help anchor inflation expectations if the public finds the commitment credible," he said.
In addition to preventing inflationary expectations and actual inflation from rising to "undesirable levels," targeting would help to check deflation, he says.
Plosser sees inflation rising during 2010 and 2011 to about 2.5%, which is tame compared with the double-digit rates of the late 70s and early 80s. An inflation rate of 2.5% certainly is not a clarion call to stock up on gold bars. However, Plosser warns that if the Fed is too slow in reducing the monetary supply as the economy picks up steam, inflation could surge much higher.
Bullard, in a speech to the National Association of Business Economists on Oct. 11, garnered headlines when he said that medium-term inflation risks might be higher than generally appreciated. He shares Plosser's oft-articulated concern that economists are overstating the importance of the so-called output gap in determining the risks of inflation. The gap measures the difference between the output of the current GDP and the potential output of the GDP. The conventional wisdom is that as long as unemployment is high and output is low, then there is little risk of inflation, despite the Fed's unprecedented expansion of the money supply. As long as we're well below full employment, you won't have too many dollars chasing too few goods. I was curious if Plosser's Oct. 20 speech was prompted in part by a growth in the public's inflationary expectations. His press spokeswoman, Marilyn Wimp, e-mailed me, "President Plosser has been a long-time advocate of inflation targeting and has talked about it in various speeches since joining the Fed. In response to your question I would answer no, that it was not the meaning in the Oct. 20th speech."
I'm still replacing my wallet with a wheelbarrow, just to be on the safe side.
WEAK-DOLLAR FEVER MIGHT BE the reason that bulls have been running wild on Wall Street (or at least were until Friday). Investment pro Ken Safian certainly thinks so. Safian, who retired this year from his eponymous research firm, has been active on the Street since the 1950s and has pretty much seen it all. He theorizes that investors view a weak dollar as just the right medicine to put the U.S. on its feet. Exports will rise and domestic consumption will decline, boosting the savings rate. These are favorable trends, he says.
Safian is not the first guy to notice the explosion of weak-dollar bulls. Rep. Ron Paul, the strong-currency crusader from Texas, groused at a hearing last week, "Everyone wants a strong economy, but I don't know how you can have one without a sound dollar. Lots of people say it's good for exports; but if you are a saver, well, who wants to lose his purchasing power?"
I talked to several economists who think a falling dollar is just what the doctor ordered, provided its slide is gradual. Year-over-year, the dollar is down 16% versus the euro and 38% against the Australian dollar, says Derek Sammann, CME Group's head of global foreign exchange.
The slide is "no big deal," says Harvard's Kenneth Rogoff, formerly an economist at the International Monetary Fund. "The trade-weighted dollar has been falling for 40 years," he says. (Trade weighting compares the dollar to a currency basket.)
Rogoff imagines that Obama administration officials are "quietly ecstatic" about the slide because it should help slow increases in unemployment as foreign demand for less-expensive American goods increases.
Every administration officially favors a strong dollar, because this is what American jingoists and our creditors like to hear. The Bush White House disavowed Treasury Secretary Paul O'Neill when he said it might be OK to let the dollar slide, recalls Christian Weller, a senior economist at the Center for American Progress. And politicians still remember "Black Monday," Oct. 19, 1987, when the market plummeted over 500 points, costing investors $500 billion. A few days earlier, Treasury Secretary James Baker had remarked that a weaker dollar might no be so bad.
Rogoff says the Obama administration is not engaged in any deliberate policy to undermine the dollar. But it isn't trying to halt its slide, either.
Any gains from a weak dollar might be temporary, says Weller. The reason: We are still dependent on fossil fuels. If demand for oil increases as the economy recovers, then the price could explode, he says. The high price in part would reflect the diminished purchasing power of the buck.
This is a balancing act: If the dollar becomes significantly weaker than the currencies of our trading partners, they would retaliate. A trigger point might be a euro worth $1.60 -- it's worth about $1.47 now. A backlash could threaten our status as the world's reserve currency.
"It's a great franchise, worth between $100 billion and $300 billion annually in lower interest costs to the economy," says Rogoff. It's doubtful we can maintain this lucrative franchise forever. Countries already are talking about an international substitute for the dollar. But Rogoff says we should try to hold on to it as long as we can.
CAP-AND-TRADE LEGISLATION, which is aimed at curbing carbon emissions, may be on the ropes in the Senate, according to Ken Meade, a partner at law firm WilmerHale who specializes in environmental law.
There is a chasm of disagreement between Senators over provisions that would address tariffs on imports produced in countries that do not have an emission-control regime.
The House version of the bill takes aim at specific energy-intensive industries in these foreign lands. A group of about 10 Midwestern Senators want a much broader border tariff.
Other Senators merely want a "sense of the Senate" provision in the bill that would allow border measures that are consistent with World Trade Organization treaties and existing bilateral trade agreements. This would allow President Obama maximum flexibility in crafting new treaties.
A hurdle is that the language of legislation is not well suited to crafting a bill that comports with our WTO obligations, says Meade.
The Midwesterners appear to be intransigent. If Congress capitulates to their demands and toughens border provisions in order to pass something, then let the trade wars begin.
E-mail: jim.mctague@barrons.com
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