Friday, June 6, 2008

How to slow the world-wide inflation

The Wall Street Journal had an interesting editorial yesterday. They explained how the falling dollar is causing worldwide inflation and they urged that the Federal Reserve borrow money in order to drive up the US interest rate in order to slow that worldwide inflation. Here is their description of the world-wide problem:

The Fed's dollar indifference has sent an inflation shock through those dollar-linked economies. This week alone, we've read about price riots in Vietnam; inflation hitting 10.1% in Kuwait; Abu Dhabi contemplating price or wage controls; South Korean and Indonesian central bankers considering rate hikes; and the Chinese letting the yuan rise ever higher to curb inflationary pressures imported from the U.S.

Many of these countries are now delinking from the greenback. Meanwhile, the dollar plunge has translated into a net transfer of trillions in wealth from the U.S. to the rest of the world. The result has been the largest decline in America's global economic influence since the 1970s.

This argument has two huge fallacies: (1) that the mercantilist countries are helpless victims of US monetary policy, and (2) that the fall in the dollar is caused by the Federal Reserve not holding up US interest rates high enough.

The Mercantilist Countries Are Responsible

The Federal Reserve is not responsible for the inflation in the mercantilist countries. The mercantilist countries are responsible for that inflation. That inflation is occurring because their central banks are increasing money supply much faster than their economies are growing. For example, the Chinese inflation is likely being caused by the Chinese government printing yuan in order to use them to buy dollars so that they can keep their currency from rising against the dollar.

But the mercantilist countries have an alternative. THEY COULD LET THEIR PEOPLE IMPORT MORE AMERICAN GOODS! The Chinese government could let their currency rise to the level it should be. They could eliminate their 30% tariff on Michigan-made auto parts and their 30% tariff on US-made vehicles (including Pennsylvania-made Harley Davidson Motorcycles). They could eliminate their just-imposed tariff on Wisconsin-made Bucyrus heavy mining equipment.

The Real Cause of the Falling Dollar is Our Trade Deficits

It is true that when the Federal Reserve borrows more dollars to raise the US short-term interest rate, it causes private foreigners to lend us more money, which can help the dollar rise in value. However, such borrowing is at best a short-run fix. It is like solving your debt problem by taking out a new loan. The Wall Street Journal is ignoring a very basic economic fact. In the long run, when you import more than you export, your currency goes down in value. The way to strengthen the dollar is to reduce the trade deficits!

The Federal Reserve is not responsible for the falling dollar. The foolish policies advocated by the Wall Street Journal and followed by US administrations since 1984 which have caused the US trade deficits to climb, and climb, and climb, are responsible.

Follow the following link to read this Wall Street Journal editorial:


1 comment:

Anonymous said...

Here's another fun fact about the Wall Street Journal editorial. At the beginning of their June 5 editorial they claimed:

"As the dollar has strengthened in welcome response, the price of gold and oil has fallen in each of the last two days."

The very next day, June 6, oil spiked up to $140 per barrel.