By Charles Kolb
It’s happening in slow motion: America’s bubble economy is finally bursting.
Overpriced equities are dropping. Inflation is rising. Thirty-year mortgage-interest rates now exceed five percent, nearly doubling from a year ago. Short- and long-term interest rates are reverting to their more normal trendlines.
“Buy the dip” will probably tempt many naïve investors to hang around our equity casinos seeking bargains. “Dead cat bounces” will appear sporadically.
It’s now abundantly clear that “modern monetary theory” is totally bankrupt. MMT proponents claimed that the United States could, with zero risk, print endless amounts of dollars and run sky-is-the-limit deficits and debts because it “borrowed” in its own currency, which is also the world’s principal reserve currency.
Over 50 years ago, former French finance minister (and later president) Valery Giscard d’Estaing called the U.S. dollar’s reserve-currency power an “exorbitant privilege.” He was right.
Like the British a century ago with their pound sterling, we’ve now abused that reserve-currency privilege and squandered trust in our currency in ways that are now prompting global efforts to replace it with other options – the Euro, China’s renminbi, IMF Special Drawing Rights or a weighted market basket of major currencies.
The dollar may be strengthening given today’s economic challenges, but the long-term risks are multiplying.
Successive British governments assumed that the pound sterling was impregnable, since no other currency could perform its reserve role. Massive deficits to finance an overly burdensome global empire plus two world wars shot the British wad: the U.S. dollar replaced the pound sterling as the global reserve currency.
For over a decade, our economy has been artificially sustained by massive federal deficits, unrealistically low interest rates and accommodative Federal Reserve policies that not only kept interest rates low but flooded the global economy with massive liquidity through repeated rounds of quantitative easing (printing money to bolster housing and equity markets). Add massive, bipartisan COVID spending and you get today’s inflation.
With the highest inflation rate in 40 years, the jig is up, but thus far, our political leadership has failed to understand how these past follies created our current economic crisis and failed to explain to Americans what their future will entail.
What Americans do understand is the daily pain of higher energy costs, food costs, and mortgage interest rates, plus supply-chain disruptions impacting millions. No amount of political spin will eliminate these harsh realities or put infant formula on supermarket shelves.
At this point, with annual inflation exceeding eight percent, we don’t know how high the Federal Reserve will have to raise interest rates. History suggests, however, that rates may have to exceed inflation to stop the upward trend.
Ronald Reagan faced a similar challenge when he became president in January 1981. Inflation was running at 13%, and Fed Chairman Paul Volcker, with Reagan’s support, raised interest rates to nearly 20%. The new president appreciated that there would be both economic and political pain, but Reagan took the heat, backed Volcker, did the right thing, and inflation rapidly subsided.
Reagan also supported policies that lowered taxes and decreased government regulation. Together with his anti-inflation efforts, these policies set the stage for a generation of economic growth.
By contrast, President Biden appears hapless, helpless and hopeless.
Hapless because he gives the impression that he inherited the situation through bad luck.
Helpless because he and some of his advisers say that presidents really can’t do much to stop inflation.
Hopeless because he’s determined to stay the course with counterproductive policies such as opposing energy independence through his war on fossil fuels, courting (incredibly) Venezuelan dictator Nicolas Maduro to increase oil production and raising taxes on wealthy Americans when a recession is looming.
Biden also believes that trillions more in deficit spending will actually reduce the deficit.
Barack Obama perfected “leading from behind” in foreign policy. Biden is doing it now in his domestic and economic policies.
The president needs to level with Americans as to what is happening economically, why it is happening and what his plans are for addressing inflation. But first, Americans need to understand.
That’s where Reagan’s communications skills worked wonders. Even Obama knew the importance of communications and once joked about naming Bill Clinton “Secretary of Explaining Stuff.”
Americans want up-front leadership plus a credible plan. It’s the plan part that will ultimately undermine Biden who shows no signs whatsoever of altering his course until, perhaps, the midterms change his mind.
Charles Kolb served as Deputy Assistant to the President for Domestic Policy from 1990-1992 in the George H.W. Bush White House