The Bradley Plan

Former congressman and presidential candidate Bill Bradley weighed in with a proposal for addressing the financial crisis. Some of the ideas are interesting – but one has the potential to wreak havoc:

What can we do? Here are five suggestions that may help ease the credit crisis, spur economic recovery sooner rather than later, and lay the groundwork for future economic growth:

- Trust a market approach first to deal with the bad assets…

- Provide a floor for home mortgages…

- Move mortgages from adjustable to fixed rates to avoid future crises…

- Invest in new companies…

- Strengthen Treasury bonds…

On that last point, Bradley argues (emphasis added): 

Given the $8 trillion in direct assistance and guarantees we’ve provided our financial system since this crisis began, the $787 billion in fiscal stimulus Congress just passed, and the existing national debt of nearly $11 trillion, many investors are expecting future inflation. Foreign investors, who own more than 30% of our Treasury debt, may be afraid to buy more. Worse, they may sell what they have, causing the dollar to plummet. To rebuild trust among foreign investors, our government must be willing to cut spending and raise taxes in the next two to three years.

Some say we can get to that when inflation heats up. I say it’s too late then. Why will China, Japan, Europe and the Gulf states continue to buy U.S. Treasurys if they believe that the inflationary consequences of America’s exploding debt will substantially devalue their investments?

In the wake of the Democrats’ ascendancy, economic policy has truly entered a time warp. The size of the debt by itself does not determine the course of inflation – monetary policy does (i.e., the Federal Reserve, NOT the U.S. Treasury, controls inflation). For example, Japan has a staggering public debt compared to ours, but has experienced persistent deflation – the reason being that, due to its abysmally low (nonexistent) rate of economic growth, the Bank of Japan’s policy rates, as low as they are, are not inflationary.

Unfortunately, because the USD is still the world’s reserve currency, the Federal Reserve has much less wiggle room than the BOJ. To prevent USD inflation, its interest rate target must, to some extent, approximate the rate of global growth rather than just domestic growth. What Bradley’s ’strengthen Treasuries’ idea proposes is that the Treasury lower domestic growth by raising taxes, and we presume that he would also have the Federal Reserve keep its target rate low to support the domestic economy. The rub is that, should the global economy out perform the U.S. – as happened in the 1970s – the USD will lose ground, inflation pressures will build, and buyers of Treasury debt will demand a higher interest rate (i.e., they will lend less money to the U.S. at existing interest rates). In other words, Bradley’s prescription is likely to do exactly what he wants to avoid!

Bill was alive in the 1970s. He should dig a little deeper into the economics of the period. If he did, he might notice the striking parallels and perhaps conclude that a lighter, more efficient tax and regulatory burden, coupled with a tighter Federal Reserve, is the right way to support our national creditworthiness.

Unfortunately, it looks to us like we are not headed in that direction any time soon. Democrats are very likely to gain a super majority in the Senate in 2011, at which point we would expect an even heavier burden on the private sector and heavier spending in the public sector. If the Fed adheres to its Humphrey-Hawkins mandate, focusing on domestic employment as well as inflation, then this public-private sector imbalance will have precisely the opposite effect that Bradley predicts. We’ve been saying it a lot lately, but our stagflation thesis still holds.