January 13, 2006,
A largely unheralded passage in the Federal Reserve’s December 13 minutes touched on globalization, and the “robust competition including from foreign producers” that is “helping to contain cost and price pressures.” According to the Wall Street Journal’s Greg Ip, the passage is one of the most prominent “factors guiding Fed Chairman Alan Greenspan in his final weeks.”
While that may be true, this apparent redefinition of inflation away from what used to be a monetary phenomenon resulting from excess money creation potentially poses risks for stocks and the economy. This is so because the debate about the efficiency of markets versus central planning has been settled, and free markets are now a fact.
The happy result is that China, India, and other formerly socialist nations will continue to grow, and in expanding will make the economies of developed countries more efficient for the addition of millions of new workers to the worldwide labor force. Citizens of developed countries will be the happy beneficiaries of a higher standard of living resulting from cheaper goods from around the world.
Importantly, the arrival of inexpensive products to our shores should not in any way be construed as a market signal that inflation has been beaten. (Nor would a converse situation indicate that these are inflationary times.) The Fed must continue to monitor the dollar’s value and not allow the arrival of low-cost goods to distort its judgment.
Unless the basics of economics have changed, low inflation is not the result of competition or cheap goods from overseas. Instead, it arises when the central bank matches currency supply with currency demand. Although there is much debate as to what is the best way to stabilize and strengthen the dollar, one sure way to warp this process would be to let exogenous factors get in the way of a supply/demand concept.
John Tamny is a writer in Washington, D.C. He can be contacted at email@example.com.