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Bernanke Backs King Dollar

A Commentary By Lawrence Kudlow

Thursday, June 05, 2008

Fed chairman Ben Bernanke made big news Tuesday by singling out the weak foreign-exchange value of the U.S. dollar as the principal culprit in "the unwelcome rise in import prices and consumer price inflation."

Are you watching this, John McCain?

Bernanke is signaling a major policy shift on the dollar. In his speech, via satellite to a conference in Barcelona, Spain, he said Fed policy and the underlying strength of the U.S. economy "will be key factors ensuring that the dollar remains a strong and stable currency."

In effect, the Fed chief is putting a floor under the dollar. But there's more here. He added that "we are attentive to the implications of changes in the value of the dollar for inflation and inflation expectations, and will continue to formulate policy to guard against risks to both parts of our dual mandate, including the risk of an erosion in longer-term inflation expectations."

The Fed head has finally figured out that the weak dollar is driving up inflation. He's also reaffirming the Fed's traditional priority of generating price stability. In the process, he may be restoring an inflation-targeting policy that has been badly undermined of late. Hopefully this means the central bank will go back to using forward-looking market-price indicators, such as the dollar and gold, in its policy decisions.

Bernanke's comments follow on similar statements made by Fed Governor Kevin Warsh, Dallas Fed President Dick Fisher and Minneapolis Fed President Gary Stern. And they mark the first time in his tenure that Bernanke has explicitly discussed the dollar-inflation connection.

Now, Treasury-man Hank Paulson in recent days has been talking about the dollar. But he still frames the discussion in terms of a strong dollar being in the national interest. Unfortunately, that phraseology remains a euphemistic reference to the Bush administration's long-held policy of dollar neglect. Not until Paulson uses the new Bernanke language -- "that the dollar remains a strong and stable currency" -- will we know the White House is shifting gears to King Dollar. Even better, Paulson could use the term "dollar appreciation."

But without question, Bernanke would not have changed his language unless he got a signoff from Paulson. So these new statements are the most hopeful sign yet that U.S. financial bigwigs are starting to get their arms around the greenback.

In currency trading following Bernanke's speech, the dollar rose significantly and gold fell. In the money markets, futures traders are pricing in a Fed rate hike, perhaps as early as late October, with a whole series of rate hikes predicted for next year. I don't expect the Fed to rush into rate hikes anytime soon. However, there is another way for the central bank to bolster the buck.

In recent months, the Fed's emergency-lending operations have injected something like $400 billion of cash reserves into the troubled banking system. So in the months ahead, while keeping the fed funds target rate steady at 2 percent, the Fed can gradually unwind some of these emergency loans as the banking system continues to heal and balance sheets continue to repair.

This would reduce some of the excess cash that has contributed to the weaker dollar. Meanwhile, a more reliable currency could end the speculative oil-and-commodity boom that has been leaking into consumer prices via the beleaguered greenback. Then, as the economy picks up later this year, the Fed can move to a gradual nudging-up of its target rate.

All this said, the Bernanke move is a huge plus for prosperity. And for the life of me, I don't know why Sen. John McCain doesn't take a cue from Bernanke and mount a King Dollar campaign of his own.

McCain needs to speak to the food-and-oil-price-hike inflationary fears of Main Street voters across the country. Why not promote a "McCain Dollar," taking a page from Ronald Reagan and his anti-inflation run in 1980? That would not only send a message to cash-strapped families, whose incomes are being swallowed by weak-dollar food and gas prices, but also a strong-dollar message around the world to bolster American power and prestige.

There are a lot of things broken in Washington right now, including the dollar. There's overspending and earmarking. There's a ridiculously complex tax system that imposes multiple tax burdens on capital, investment and saving. There's the entitlement problem. And the energy system needs to be totally deregulated so that free-market forces can promote a full portfolio of conventional and new energy sources.

Big Mac can fix what is broken in Washington, including the busted dollar. The sooner McCain adopts this reform message, the closer he's going to get to victory in November.

Quite simply, a strong currency -- along with pro-growth tax, spending, entitlement and energy reform -- is the winning message.

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