On the day after an unusually important Fed policy meeting, both gold and stocks severely rebuked the central bank’s decision to take no action in support of the weak dollar or to curb rapidly growing inflation. Gold spiked $30, a clear message that Bernanke & Co. won’t stop inflation. Stocks plunged over 350 points, an equally clear message that the Fed’s cheap-dollar inflation is damaging economic growth.
Inflation, which is caused by excess dollar creation, is the cruelest tax of all. It is a tax on consumer and family purchasing power. It is a tax on corporate profits. It is a tax on the value of stocks, homes and other assets.
Crucially, the capital-gains tax – the most important levy on all wealth-creating assets – is un-indexed for inflation. Hence, long before Barack Obama or Congress can legislatively raise the capital-gains tax rate, rising inflation is increasing the effective tax rate on real capital gains.
By doing nothing at the June 25 meeting, the Fed turned its back on the very inflation-tax problem it helped create.
Former Fed Chairman Paul Volcker, who is advising Obama’s presidential campaign, recently told the New York Economics Club that inflation is real and the dollar is in crisis. Soon after, Fed head Ben Bernanke changed his tune, pledging greater vigilance on inflation and hinting at a defense of the dollar. Treasury man Henry Paulson and President Bush also stepped up their rhetoric regarding a stronger greenback.
But words were no substitute for actions.
Paul Volcker is still highly regarded as the greatest inflation fighter of our time. Working with Ronald Reagan, it was Volcker who slew the inflation dragon in the 1980s. The combination of tighter monetary control from the Fed and abundant new tax incentives from Reagan launched an unprecedented 25-year prosperity boom characterized by strong growth and rock-bottom inflation. At the center of the boom was a remarkable 12-fold rise in stock market values, a symbol of the renaissance of American capitalism. But that was then, and this is now.
The Volcker anti-inflation model always argued that price stability is the cornerstone of economic growth. Yet it appears that today’s Fed has reverted to a 1970s-style Phillips-curve mentality that argues for a trade-off between unemployment and inflation, rather than the primacy of price stability.
Yet history teaches us otherwise. It states that since rising inflation corrodes economic growth, inflation and unemployment move together – not inversely. Even in the last 18 months this is proving true. Inflation bottomed around 1 percent in late 2006. Unemployment bottomed at 4.4 percent about six months later. Today, the CPI inflation rate has climbed to over 4 percent, wholesale prices have jumped to 7 percent, and import prices have spiked to 18 percent. Unemployment, meanwhile, has moved up to 5.5 percent.
Over the past five years, the greenback has lost 40 percent of its value. Oil is around $140 a barrel. And gold, now trading above $900 an ounce, is warning that if the Fed fails to stop creating excess dollars, inflation could rise to 6 percent or 7 percent.
If Fed policymakers reconvene immediately to right their wrongheaded mistake, the value of our money could be quickly restored. The next scheduled Open Market meeting is Aug. 5, but they needn’t wait that long.
Let’s hope they come to their senses.