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The Fed's Fighting the Wrong Battle

Raising rates is the wrong weapon to use against asset inflation. It's time Greenspan trotted out Reg T.

So the

Federal Reserve

raised rates by another quarter-point and, as in June, nothing happened. Not to stock investors, anyway. Only to the poor sods with $25,000 incomes trying to qualify for that $75,000 mortgage on a $90,000 house.

And for what?

The New York Times'

lead did


say that the Fed raised rates to fight inflation. It said, "The Federal Reserve raised rates today ...


the action should help


inflation." As the


continued, in doing so, the Fed was "brushing aside arguments from farmers, labor unions, manufacturers and some politicians that there was no inflation to fight."

This subtlety was lost on the


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own Business Digest headline writer, who wrote, "Fed Raises Interest Rates to Help Avert Inflation." In a lapdog editorial, the


also praised

Alan Greenspan

for "acting cautiously to ... head off a resurgence of inflation." As usual, this attitude carried over to the local press. My city daily headlined it: "Fed Bumps Rates to Beat Inflation."

Why does our press parrot this propaganda? It gives the Fed credit where none is due, and sometimes where none is even claimed. The Fed itself stated that future inflation risks are "markedly diminished," which is a way of conceding, without quite saying so, that they weren't substantial to begin with.

Pursuing the case against the


, consider

Sylvia Nasar's

story in last Sunday's edition. Under the accurate headline "Inflation: It Just Doesn't Add Up," Nasar quotes a bevy of prominent economists -- Alan Blinder, Jeffrey Frankel, Robert Gordon, Paul Krugman, Alan Krueger and Larry Katz -- who were wrong in believing inflation would rise just because unemployment was low, and now basically admit it. Doesn't the


editorial writer read his own paper?

To repeat. There isn't any inflation. The Fed hasn't prevented inflation by raising rates. If inflation were accelerating because of low unemployment, 50 basis points would not prevent it! This isn't a pre-emptive strike. It's a pre-emptive pinprick. And the people getting pricked are working families and small businesses, while stock investors and the banks -- of course -- come out fine.

Speaking of stocks, my old boss, the former chairman of the

House Banking Committee


Joint Economic Committee

Henry S. Reuss, has a better idea. He writes in the latest

FOMC Alert

, a splendid little publication of the

Financial Markets Center:

It should be plain that the type of inflation we are now experiencing is not commodity inflation, not services inflation, not wage inflation, but stock market inflation.

And, for an alternative to the "blunderbuss" technique of raising interest rates, Reuss writes:

Yes, there is a rifle shot method to counter stock market inflation. It is known as Regulation T.

Regulation T was put in place following the

Securities and Exchange Act of 1934

; Reuss monitored it for the

Office of Price Administration

in 1941. It is the regulation that empowers the Fed to set margin requirements on brokers' loans. But since 1974, this requirement has been stuck at 50% of assets, while since 1993 margin borrowing has tripled in relation to GDP. In relation to capitalization, margin debt now stands at levels surpassed only in the run-up to the crash of 1987. The actual volume of margin debt, $177 billion in June, is up 80% over 1996.

How about it, boys and girls? Worried about the inflation we actually have? Instead of pushing up interest rates and knocking down the secretaries and nurses out there who are just trying to buy a house, why not push up the margin requirement to, say, 60% or 70%? As the Financial Markets Center's staff writer puts it:

"Even the chairman at his most obfuscatory might have a hard time explaining why free-market principles prohibit margin adjustments to control asset inflation but justify interest rate adjustments to contain rising wages."

Particularly when wages aren't, in fact, rising very much. Back in


James J. Cramer

got it right, both on the reality and the reflexive attitudes of the press.

Growth without inflation, indeed growth with deflation, is the norm. ... So when you hear the Fed needs to tighten stuff, remember, journalists have to craft a story of the day.

There was only one problem with that rather good insight of James J.'s. He claims that it contradicts something he learned from "that Ec 10 course I took with Galbraith, you know, the one with that big Samuelson textbook."

I checked with my dad this morning. Though John Kenneth Galbraith did lecture once or twice a year in Ec 10, he never taught the class after leaving






around 1938. And in those early days, the textbook was by Taussig, not Samuelson.

Still, if Cramer really is old enough to have taken that class, I suppose we can forgive him for forgetting who wrote the text.

Full disclosure: James K. Galbraith taught an introductory economics once, around 1978, but that was at Yale -- and Cramer didn't take that one, either.

James K. Galbraith is author of Created Unequal: The Crisis in American Pay (Free Press, 1998) and director of the University of Texas

Inequality Project. A professor at the University of Texas at Austin and senior scholar at the Levy Economics Institute, he worked for many years on the staff of the House Banking Committee, where he conducted oversight of the Federal Reserve. He welcomes your feedback at