"Greatly Inflated Expectations"

Jerry Bowyer says the great supply-side debate of 2006 is coming to an end over at National Review Online:

For about two years now there has been a deep division among members of the supply-side movement over the topic of inflation. That debate will eventually draw to a close — as all forecasting debates eventually must (among open-minded people) as the data gradually appear.

The science of economic forecasting, like any science, basically works like this: You form a picture in your mind of how you think the world works; you predict what will happen if the world really does work that way; then you wait and see what happens. If your prediction turns out to be wrong, your theory, then, must also be wrong.

Larry Kudlow, Arthur Laffer, and the Bush administration thought the world worked like this: Gold will give you some useful knowledge about future inflation, but it is not an absolutely reliable indicator in and of itself. Kudlow has made this case on both his blog and his TV show, Kudlow & Co. Laffer has said as much on Kudlow’s show, which has become the command center for the no-inflation camp. And the chairman of the president’s Council of Economic Advisors has predicted “modest inflation” after looking at “market indicators” such as interest rates.

BuzzCharts is in agreement. We have argued that the principle that made gold a good indicator (the wisdom of markets over planners) made the combination of all relevant markets (gold, other commodities, interest rates, and even stocks) an even better indicator.

Other respected supply-side analysts (some with truly outstanding track records) have focused mainly on gold in forecasting future inflation, and because of this have warned of higher inflation. So far, that inflation has not appeared in consumer prices. Rather — instead of seeing manageable levels of inflation turn into high inflation — we’ve gotten a sniff of deflation. As of this writing, prices have generally been dropping for the past couple of months.

Is the debate over? Not yet. However, the federal printing presses were running at their hottest in 2003 and we’re near the end of 2006. It’s getting tougher and tougher to believe that inflation is still languishing somewhere in the money pipeline. With each month of moderate (or even negative) price growth, the inflation case weakens, and so does the “gold-only” theory on which it is based.

Why will the “gold-only” crowd turn out to be wrong? What can we learn about forecasting of all kinds from this episode?

Stay tuned to BuzzCharts.

— Jerry Bowyer is an economic advisor to Blue Vase Capital Management and the author of The Bush Boom.