My optimistic view of Alan Blinder as vice chairman of the Fed has met with hoots and catcalls from supply-side friends, who believe his inflationist bias will not, as I suggest, undergo mutation in the hothouse of Alan Greenspan's Federal Open Market Committee. Going in, we have to acknowledge that Blinder will have a negative influence on policy, and so will Janet Yellen, the other academic Keynesian nominated to the Fed by President Clinton. In his Senate Banking Committee nomination today, Blinder clearly revealed himself to be a variety of a Phillips Curver, in that he believes inflation is caused by economic growth. He expressly stated that he didn't think the economy could grow at more than 3% in the next two years without causing inflation. This is pretty bad and will take considerable effort for Greenspan to overcome.
In the May 16 Business Week, Paul Craig Roberts writes "Now Easy Money Will Talk at the Fed," arguing that this kind of thinking is the reason why "demand-side economics cannot deliver economic growth without inflation. That's why Blinder and Yellen will soon be arguing that a little more inflation won't hurt."
Keynesians don't make good inflation fighters because they blame inflation on nonmonetary factors. In place of too much money chasing too few goods, Keynesians blame greedy oil sheiks, greedy labor unions, greedy businesspeople, and greedy commodity speculators. The same people who deride the 1980s as the Greed Decade attribute the decline in inflation in that decade to less greed on the part of oil sheiks, unions, businesses and speculators. Apparently, any contradiction is better than giving supply-side policy credit.
Blinder thinks we should just accept inflation as a redistributive device that hurts the rich more than the poor. Reagan, it turns out, protected wage earners by indexing the personal income tax for inflation -- but did not do the same for the capital gains income of the rich. If inflation gets out of hand, Blinder says we can suppress greed with wage and price controls.
Blinder would quibble with this characterization, but it is not that far off. There is a story circulating today on Capitol Hill that when Blinder this week was interviewed by a Republican Senator, he was asked what single piece of information he would value most in deciding whether to tighten or ease. He said GNP. If he could have another piece of information? The unemployment rate. How about the gold price? Way down the list, far below other commodity prices that are more important, like lumber, he is said to have replied. I'm sure the story is true, and it shocked me, because Blinder has been among the most skeptical in the profession of macroeconomic aggregates, i.e., statistics collected by government bureaucrats. In 1980, he demonstrated the foolishness of relying on price indices for reliable information. It is difficult to believe the same fellow does not understand how utterly stupid it is to base the Fed's daily banking decision on a GNP statistic or unemployment number.
In 1971, I first met Art Laffer when he was being pilloried in the economics profession for his prediction, as chief economist of OMB, that GNP in fiscal 1972 would hit $1.065 trillion. The consensus was more like $1.045 trillion and the lowest number was Alan Greenspan's, at Townsend-Greenspan, of $1.028 trillion. When the year ended, the Commerce Department reported that Greenspan had hit the number on the nose, and Laffer returned to the University of Chicago amidst general snickering. Three years later, only Fortune magazine noticed when Commerce issued its final revision of 1972 GNP, putting it at $1.063, with Laffer snatching the blue ribbon from Greenspan. In the years since, virtually every serious academic study has shown the unreliability of GNP numbers, which Reuven Brenner of McGill University demonstrates in his brilliant forthcoming book, Labyrinths of Prosperity (which favorably cites Blinder's 1980 work on price indices).
This is why "stupid" is not too strong a word to describe a GNP target. If Blinder has to decide on May 17 whether to tighten or ease, and asks first for the GNP number, he will get a number that will be revised over three years before it is considered safe enough to record as final. In 1971, he would be voting to "ease," and three years later saying, "Goshdarn, we should have tightened." The unemployment statistics are scarcely better, totally worthless when it comes to deciding when to inject fresh reserves into the banking system and when to drain liquidity, which is really all that Blinder is expected to do. Choosing lumber prices over gold as a signal is ludicrous, but typical of a Phillips Curver, who would think that too many houses being built is inflationary. When lumber prices collapsed after the midwest floods stalled housing starts last year, are we to imagine Blinder urging Greenspan to ease?
My guess would have been that Blinder would have told the Senator he'd ask for an index of commodity prices. This at least gets us to a real number set by auction markets, not bureaucrats, with the side effects of floods, drought, and the Spotted Owl minimized. This is why Greenspan cites gold as the best commodity to target, because its flow is tiny compared to its stock. Lumber's use is enormous compared to its inventory, and should not even be included in an index.
It is not known what Blinder thinks of Treasury's attempt to defend the dollar against the yen this past week, the practice we have been ridiculing for 20 years. In a note I faxed yesterday to Lloyd Bentsen, I tried to explain that because the Fed is targeting the fed funds rate at 3.75%, it is literally impossible for it to buy dollars in the hope of bidding it up against the yen. This will raise fed funds above 3.75%, requiring the Fed to sell dollars simultaneously. On Wednesday, that is exactly what the Fed was doing, mopping up dollars in the Pacific and printing $2.5 billion more and dumping them in the Atlantic. The practice might have made some sense in the 19th century, in the days of wooden sailing ships. In the age of electronic banking, ink money travels at the speed of light. As I explained to the Treasury Secretary, if you wish the dollar to rise against the yen, then you must ask Chairman Greenspan to put aside his fed funds target and drain bank reserves until the dollar/yen rate is where he wants it to be. Y105? Y110?
Of course, if Bentsen does this, he is on a Yen Standard! Which would be fine with me at the present moment, because the Bank of Japan has done a better job than the Fed these past several months in its management of Japan's debt. In The Wall Street Journal today, Larry Kudlow argues that the Bank of Japan should end its three-year deflation, as evidenced by the yen gold price, through monetary ease. As I wrote Wednesday, this was also my view until I looked more closely at the path of Japan's gold price and found that Japan essentially ended its deflation a year ago, and should not ease unless gold falls below Y39,000. If the Fed were now on a Yen Standard, the bond market would not have to worry about the inflationary influence of Blinder and Yellen. As it is, the creditors of the United States have to brace themselves as the two academic Keynesians go through basic training.
HAITI UPDATE: Just as it seemed President Clinton might pull the trigger, Senate Minority Leader Bob Dole yesterday afternoon issued a statement calling for a bipartisan fact-finding commission to "take a fresh look at the situation in Haiti -- what the democratically elected parliamentarians think, why Prime Minister Malval resigned in frustration, whether a peaceful solution is possible." This could be a milestone in U.S. post-Cold War foreign policy, with an attempt made to discover the facts before the President starts bombing, á la Waco. A month ago, I heard Henry Kissinger argue plaintively that we must stop making foreign policy decisions based on where the CNN crews aim their cameras. In the last week, the propaganda about Haitian atrocities and an Aristide follower's hunger strike had built a sense of inevitability about a U.S. military intervention. It's hard to imagine Clinton resisting the suggestion: "Allowing such a commission to examine the best course to national reconciliation in Haiti before any additional action is a modest step," said Dole. "I hope to work with the President and his advisers in forming such a commission." The Congressional Black Caucus should be thrilled with Dole's intercession. Hooray for facts!