"Hi Bill, I have been reading the blog for awhile now, its been very interesting. Thanks. I have a question: Doesn't an economy that is slowing by itself negate the need for higher rates? From my ECON 201 days, I thought that the point of raising interest rates is to cool down an economy that is overheated, and lowering interest rates to juice up a cool economy. With the economy slowing already, won't that take pressure off of prices? Thanks. /Todd (Western Canada)"

Hi Todd,

Thanks for reading. Please tell your friends.

Re your query, there is a difference between economic growth rate (i.e., output), and inflation. Presently the U.S. (and Canada) has a slowing (but still growing) economy, as well as rising inflation.

The Fed is raising rates in order to stop price inflation.

Unfortunately that also burdens the economy, so Greenspan is pleading with govt to do things along the lines of lowering spending (which is hopeful), raising taxes (not likely under Bush), lowering the spending on the war against terrorists (which he's hoping Bush can convince the Europeans, Canadians and the Japanese to help pay for), etc.

Greenspan would also like to see Americans "buy American" which would boost GDP (by lowering imports).

But the current state of affairs is not a Fed-created problem. As long as corporations are doing buy-backs, like almost half the Dow 30 components, or dividending billions like Microsoft, and banks are lending to investors who are speculating on new housing by buying 10 and 20 units at a time, and on and on, then people are using that money to speculate.

Speculation is not creating savings, and it is not investing in wealth creating assets, so it is a problem.

The Fed has to stop that problem and is doing the job by raising rates.

At some point, say with mortgage rates at 8.5 or 9 pct, the real estate speculators will stop. In addition, with very high margin loan costs, commodity futures contracts will come back in line with real demand for the underlying commodity, and so forth.

The last time something like this happened to the U.S., as I recall, was in the early 1970's and President Nixon brought in wage-and-price controls to stop the speculation, which caused a real upset to free capital markets. The Fed held back too many years from raising rates because the economy was too weak (then too).

So what happened? The equity market went into a devastating bear market (1973-1974) that caused a long and slow death to equities that didn't really come back to life until mid-1982.

Ultimately, the inflation that started in the early 1970s (caused by the spending on the Vietnam War) kept right on going until 1980, with gold spiking to $800 and silver at $50 (thereabouts).

It took 20 pct interest rates to finally break the back of inflation in that cycle.

This time around, the Wars Against Iraq, in the Balkans (former Yugoslavia), and Afghanistan, have really helped certain (Dow 30) companies like General Electric, Boeing, Honeywell and United Technologies, but have also created huge damage to the U.S. economy.

It is arguable -- back and forth -- whether the monetarist or supply-side economic schools or any other approach could have resolved the problem that exists today, and is now becoming apparent, which is stagflation.

Stagflation is not a Fed-created problem. Others (not the Fed) have written checks that Greenspan is running around trying to cash, and he's found that he can't. He needs help from Congress; he needs a change in attitude in the American consumer; and he needs banks to stop lending to speculators.

Then, possibly, will he (the Fed) be able to slow or stop the move to higher interest rates.

I don't know Alan Greenspan from Jimmy Greenspoon, but I know that the Fed, however it is managed, and by whomever, has a serious problem at hand. And I know it's not going to stop from worsening until the PPI/CPI/Beige Book data that I have been pointing you to in these pages stops its present upward trend and starts to show PPI and CPI trend lines that point down.

/Bill