Inflation Is Real. Bernanke’s Right. Kohn’s All Wet.

Driven up by the cheap dollar, U.S. import prices surged nearly 18 percent above year-ago levels, according to a new report out today. Even removing all energy-related fuels, the surge is still 6 percent. As recently as late 2006, total import inflation was zero. And the core rate was one-half of 1 percent in early 2006. So inflation is getting worse and we may see these price hikes filter into tomorrow’s consumer price report.

So let’s give a couple of cheers to Fed head Ben Bernanke, who has belatedly woken up to the inflationary perils of the cheap dollar. Recently Bernanke pledged to “strongly resist” any decline in public confidence over stable prices. Essentially he has put a floor underneath the dollar. He may even take back the last quarter-point rate cut in July, raising the Fed’s target rate to 2.25 percent. And today’s strong retail sales report, with upward revisions to April and March, confirm Bernanke’s view that the economy is likely getting better, not worse.

Now here’s the rub. Incredibly, Bernanke’s number two, Donald Kohn, gave a speech in Boston contradicting the Fed chairman. Relying on a Phillips-curve tradeoff between inflation and unemployment used by liberal economists who disagree with Milton Friedman’s principle that inflation is a monetary phenomenon, Kohn tells a Boston audience that “appropriate monetary policy following a jump in the price of oil will allow, on a temporary basis, both some increase in unemployment and some increase in price inflation.” And then he goes on to say that too much attention to inflation will cause unemployment to go too high.

In other words, right out of the Jimmy Carter 1970’s stagflationary playbook, a little more inflation is always okay if it creates a little less unemployment.

This flawed thinking decimated the 1970’s economy and drove both inflation and unemployment sky high. Kohn not only undercut his own boss Bernanke, he also undermined efforts by President Bush and Treasury man Henry Paulson to restore confidence in the U.S. greenback at the G8 meeting about to begin.

Although Kohn was originally appointed to the Fed by President George W. Bush, one has to wonder if Kohn isn’t thinking about an Obama presidency, and perhaps even damaging today’s economy to make Republicans look worse and Obama’s pessimistic economic view look better.