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July 14, 1995
Retail sales took an unexpected turn for the better, doubling forecasts for June, and this sign of rebound has taken mortgage rates back to the high sevens. This is the third bounce up from a 7.625% bottom in six weeks, and rates are not going to break lower without bad economic news.
Though the announcement may be premature, it seems that an inflation victory has been won: last month's producer price index fell .1%, and consumer prices rose only .1%. That's two straight months of 1950's style inflation.
During 1995, public attention has focused on the Fed and the economy, and largely ignored the purpose of the whole Fed tightening exercise: to prevent inflation.
However, the victory over inflation is encouraging a crowd of second guessers. Their general train of argument: "There wasn't any inflation when the Fed started its phony war, nor any time since. The Fed has squashed the economy for no reason, and shouldn't have raised rates at all."
This is a difficult argument to counter, as there is no way to find out what inflation would be like now if the Fed had not tightened. There is a very old, very bad joke which illustrates the disagreement between the Fed-believers and the second-guessers.
"How do you hide an elephant in a bowl of jelly beans?" Groan from respondent victim: how?. Punch line: "Paint its toenails all different colors." Rude gesture from victim listener. "You don't trust me? Look, in all the bowls of jelly beans you've seen, have you ever been able to pick out one, single elephant?"
There is good evidence that the Fed did in fact pre-empt an inflation interlude, and there is a matter of philosophy entirely on the side of Mr. Greenspan.
Inflation numbers last winter showed an unmistakable surge in prices of raw and intermediate goods. Materials 'way up the food chain from finished ones had prices inflating at a full one percent per month. The economy was still growing at a 6% clip in the fourth quarter of 1994, and in February 1995, the raw goods inflation seemed certain to ripple all the way to consumer prices, then wages.
Then, just in time, a year of Fed tightening began to bite into the economy. Growth fell to 3% by this Spring, has been weaker since, and the slowdown cut the props out from under incipient inflation. Now, raw goods prices are growing no faster than the .2-.3% rate of finished goods.
In a gray nutshell, the philosophy of inflation fighting is to make sure that the elephant stays invisible. Once the elephant is in full view, with wages rising too fast, and CPI doubled, it takes a nasty recession to remove it from your jelly beans. Mr. Greenspan often argues that it's better to pre-empt and be wrong than to be late and play catch-up: it's always easier to ease than to tighten.
Isn't it amazing what a little nail polish will do?
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