Monday, August 27, 2007

Growth Solution

A full Monty easing of Fed policy, including fed funds rate cuts on top of their discount rate opening, could lead to a stronger dollar and a much weaker gold price, according to John Tamny of RealClearMarkets and Paul Hoffmeister of Bretton Woods Research.

Does this sound counter-intuitive? Well, the missing link is economic growth.

The idea here is a simple one. Cutting the fed funds rate removes a tax on money that has weakened the economy and the dollar in recent years. This tax on money has also strengthened the gold price, a symbol of higher inflation.

Interestingly, inflation hawk Steve Forbes agrees with this idea. On Kudlow & Company tonight John Tamny, a former Goldman Sachs banker turned economic journalist, suggested that a 4.5 percent fed funds target rate could bring the gold price all the way down to $550. That's the power of rising money demand.

Paul Hoffmeister, a former staffer to the late Jude Wanniski, argues that a lower fed funds rate would provide new cash liquidity that would bolster investment and economic growth. This growth, in turn, would absorb any excess liquidity and therefore it would hold down inflation.

Most Wall Street economists believe that a lower fed funds rate would speed up economic growth and increase inflation. However, the supply-side view offered by Tamny and Hoffmeister, and endorsed by Forbes, argues that faster economic growth leads to lower inflation.

In other words, at today's lower tax rates, more liquidity would safely and constructively boost the economy towards a much needed growth rebound. And, growth solves a lot of problems. Growth solves credit problems. It also solves a softening of job creation. It also solves inflation (which has not been a huge problem).

Perhaps most important, growth solves the soft dollar problem, which has become chronic in recent years.

I find myself agreeing with the Tamny-Hoffmeister view. It may sound counter-intuitive, but it makes perfect sense in the logic of supply-side economics. The key right now is a lower fed funds rate target from Bernanke & Co. Hats off to Tamny and Hoffmeister.

There is a growth solution.