Bracing Ourselves

Afghanistan Will Be a Quagmire for al Qaeda

The war on terror will end once we've empowered the Muslim majority to stand up against extremists.

JOSEPH LIEBERMAN

Although President Barack Obama and all of us in Congress are understandably focused on the economic crisis, we also face multiple crises in the rest of the world -- beginning with the war in Afghanistan. Security there has been deteriorating as the insurgents have grown in strength, size and sophistication, expanding their influence over an increasing swath of territory.

Reversing the downward spiral will not be easy. But as Gen. David Petraeus once said of another war, "Hard is not hopeless." And we possess considerable strengths in this fight.

The biggest strength is the American military, which through the crucible of Iraq has transformed itself into the most effective counterinsurgency force in history. Although Iraq and Afghanistan are very different, many of the guiding principles of counterinsurgency do apply to both theaters -- most importantly, the need to provide security for the population. Moreover, our troops will be redeploying from Iraq to Afghanistan with the momentum, experience and morale that comes with success.

We also have an ally in the Afghan people -- a proud people with a proud history. Although their frustration with our coalition is growing, Afghans are not eager to return to the tyranny and poverty of the Taliban. That is why the insurgents have not won their support and must resort to self-defeating tactics of cruelty and coercion.

The other critical strength, and reason for hope, is the broad support for success in Afghanistan in the new administration and Congress. Mr. Obama has made clear this is a war he intends to win. He has pledged to deploy more troops and appointed one of our most talented diplomats, Ambassador Richard Holbrooke, as special envoy for Afghanistan and Pakistan. The combination of Mr. Holbrooke and Gen. Petraeus led by Secretary of State Hillary Clinton and Secretary of Defense Robert Gates is not a team to bet against.

That, then, is the good news. The bad news is that, even if we do everything right, conditions are likely to get worse before they get better, and the path ahead will still be long, costly and hard. The president's pledge to send more troops to Afghanistan is absolutely necessary and right -- but turning the tide will take more than additional troops. In fact, we must match the coming surge in troop strength with at least five other "surges" equally important to success.

- First and most importantly, we need a surge in the strategic coherence of the war effort. As we learned in Iraq, success in counterinsurgency requires integrating military and civilian operations into a seamless and unified strategy. In Afghanistan, we do not have in place a nationwide, civil-military campaign plan to defeat the insurgency.

This is an unacceptable failure. It is also the predictable product of a balkanized military command structure, in which different countries are left to pursue different strategies in different places. The international civilian effort in Afghanistan is even more disorganized, as well as unsynchronized with the military.

Unquestionably, it is a good thing so many countries are contributing to the fight in Afghanistan, and we owe a great debt of gratitude to our allies for their sacrifices. But we also owe them success, and that demands an integrated campaign plan and stronger American leadership.

- Second, we need a surge in civilian capacity. The U.S. Embassy in Kabul needs to be transformed and expanded, with the necessary resources and the explicit direction to work side by side with the military at every level. In particular, the civilian presence must be ramped up outside our embassy -- at the provincial, district and village levels, embedding nonmilitary experts with new military units as they move in.

- Third, we need to help surge the Afghan war effort. This means expanding the Afghan army to 200,000 or more, and ensuring they are properly equipped, paid and mentored.

The U.S. needs to take tough action to combat the pervasive corruption that is destroying the Afghan government and fueling the insurgency. This requires a systemic response, not just threatening specific leaders on an ad hoc basis. Specifically, we must invest comprehensively in Afghan institutions, both from top-down and bottom-up.

In doing so, the U.S. should embrace a policy of "more for more" -- specifically, by offering the Afghan government a large-scale, 10-year package of governance and development aid in exchange for specific benchmarks on performance and progress.

- Fourth, we need a surge in our regional strategy. As many have observed, almost all of Afghanistan's neighbors are active in some way inside that country. Some of this activity is positive -- for instance, aid and investment -- but much of it is malign, providing support to insurgent groups. We must help "harden" Afghanistan by strengthening its institutions at both the national and local levels, empowering Afghans to stop their neighbors from using their country as a geopolitical chessboard.

The U.S. can help by beginning to explore the possibility of a bilateral defense pact with Kabul, which would include explicit security guarantees.

Some neighbors are hedging their bets today because they fear what happens "the day after" America grows tired and disengages from the region, as we did once before, after the Soviet withdrawal from Afghanistan. Nothing will discourage this destabilizing behavior better than a long-term American commitment to Afghanistan.

- Fifth, success in Afghanistan requires a sustained surge of American political commitment to the mission. Fortunately, and unlike Iraq, the Afghan war still commands bipartisan support in Congress and among the American people. But as more troops are deployed to Afghanistan and casualties rise, this consensus will be tested.

Indeed, there are already whispers on both the left and the right that Afghanistan is the graveyard of empires, that we should abandon any hope of nation-building there, additional forces sent there will only get bogged down in a quagmire.

Why are these whisperings wrong? Why is this war necessary?

The most direct answer is that Afghanistan is where the attacks of 9/11 were plotted, where al Qaeda made its sanctuary under the Taliban, and where they will do so again if given the chance. We have a vital national interest in preventing that from happening.

It is also important to recognize that, although we face many problems in Afghanistan today, none are because we have made it possible for five million Afghan children -- girls and boys -- to go to school; or because child mortality has dropped 25% since we overthrew the Taliban in 2001; or because Afghan men and women have been able to vote in their first free and fair elections in history.

On the contrary, the reason we have not lost in Afghanistan -- despite our missteps -- is because America still inspires hope of a better life for millions of ordinary Afghans and has worked mightily to deliver it. And the reason we can defeat the extremists is because they do not.

This, ultimately, is how the war on terror will end: not when we capture or kill Osama bin Laden or Mullah Omar -- though we must do that too -- but when we have empowered and expanded the mainstream Muslim majority to stand up and defeat the extremist minority.

That is the opportunity we have in Afghanistan today: to make that country into a quagmire, not for America but for al Qaeda, the Taliban and their fellow Islamist extremists, and into a graveyard in which their dreams of an Islamist empire are finally buried.

Mr. Lieberman is an Independent Democratic senator from Connecticut. This op-ed is adapted from a speech he delivered last week at the Brookings Institution.

Bracing Ourselves

Bracing Ourselves

America prepares for the worst, and Republicans suddenly seem serious.

• By PEGGY NOONAN

All week the word I kept thinking of was "braced." America is braced, like people who are going fast and see a crash ahead. They know huge and historic challenges are here. They're not confident they can or will be met. Our most productive citizens are our most sophisticated, and our most sophisticated have the least faith in the ability of our institutions to face the future and get us through whole. They have the least faith because they work in them.

Tuesday I talked to people who support a Catholic college. I said a great stress is here and coming, and people are going to be reminded of what's important, and the greatest of these will be our faith, it's what is going to hold us together as a country. As for each of us individually, I think it's like the old story told about Muhammad Ali. It was back in the 1960s and Mr. Ali, who was still Cassius Clay, was a rising star of boxing, on his way to being champ. One day he was on a plane, going to a big bout. He was feeling good, laughing with friends. The stewardess walked by before they took off, looked down and saw that his seatbelt was unfastened. She asked him to fasten it. He ignored her. She asked him again, he paid no attention. Now she leaned in and issued an order: Fasten the seatbelt, now. Mr. Clay turned, looked her up and down, and purred, "Superman don't need no seatbelt."

She said, "Superman don't need no airplane. Buckle up." And he did.

We all think we're supermen, and we're not, and you're lucky to have a faith that both grounds you and catches you.

But during the part in which I spoke in rather stark terms of how I see the future, I think I saw correctly that the physical attitude of some in the audience was alert, leaned forward: braced. Again, like people who know a crash is coming. Afterward I asked an educator in the audience if I was too grim. He looked at me and said simply: No.

A sign of the times: We had a good time at lunch. It is an era marked by deep cognitive dissonance. Your long-term thoughts are pessimistic, and yet you're cheerful in the day to day.

On Wednesday, in an interview with Politico, Dick Cheney warned of the possible deaths of "perhaps hundreds of thousands" of Americans in a terror attack using nuclear or biological weapons. "I think there is a high probability of such an attempt," he said.

When the interview broke and was read on the air, I was in a room off a television studio. For a moment everything went silent, and then a makeup woman said to a guest, "I don't see how anyone can think that's not true."

I told her I'm certain it is true. And it didn't seem to me any of the half dozen others there found the content of Cheney's message surprising. They got a grim or preoccupied look.

The question for the Obama administration: Do they think Mr. Cheney is essentially correct, that bad men are coming with evil and deadly intent, but that America can afford to, must for moral reasons, change its stance regarding interrogation and detention of terrorists? Or, deep down, do the president and those around him think Mr. Cheney is wrong, that people who make such warnings are hyping the threat for political purposes? And, therefore, that interrogation techniques, etc., can of course be relaxed? I don't know the precise answer to this question. Do they know exactly what they think? Or are they reading raw threat files each day trying to figure out what they think?

The bad thing about new political eras is that everyone within them has to learn everything for the first time. Every new president starts out fresh, in part because he doesn't know what he doesn't know. Ignorance keeps you perky.

On the economy, I continue to find no one, Democrat or Republican, who has faith that the stimulus bill passed by the House will solve anything or make anything better, though many argue that doing absolutely nothing will surely make things worse by not promising at least the possibility of improvement through action.

Meanwhile, the inquest on President Obama's great stimulus mistake continues.

His serious and consequential policy mistake is that he put his prestige behind not a new way of breaking through but an old way of staying put. This marked a dreadful misreading of the moment. And now he's digging in. His political mistake, which in retrospect we will see as huge, is that he remoralized the Republicans. He let them back in the game.

Mr. Obama has a talent for reviving his enemies. He did it with Hillary Clinton, who almost beat him after his early wins, and who was given the State Department. He has now done it with Republicans on the Hill. This is very nice of him, but not in his interests. Mr. Obama should have written the stimulus bill side by side with Republicans, picked them off, co-opted their views. Did he not understand their weakness? They had no real position from which to oppose high and wasteful spending, having backed eight years of it with nary a peep. They started the struggle over the stimulus bill at a real disadvantage. Then four things: Nancy Pelosi served up old-style pork, Mr. Obama swallowed it, Republicans shocked themselves by being serious, and then they startled themselves by being unified. But it was their seriousness that was most important: They didn't know they were! They hadn't been in years!

One senses in a new way the disaster that is Nancy Pelosi. She was all right as leader of the opposition in the Bush era, opposition being joyful and she being by nature chipper. She is tough, experienced, and of course only two years ago she was a breakthrough figure, the first female speaker. But her public comments are often quite mad—we're losing 500 million jobs a month; here's some fresh insight on Catholic doctrine—and in a crisis demanding of creativity, depth and the long view, she seems more than ever a mere ward heeler, a hack, a pol. She's not big enough for the age, is she? She's not up to it.

Whatever happens in the Senate, Republicans have to some degree already won. They should not revert to the triumphalism of the Bush era, when they often got giddy and thick-necked and spiked the ball. They should "act like they been there before." They should begin to seize back the talking mantle from the president. And—most important—they must stay serious.

The national conversation on the economy is frozen, and has been for a while. Republicans say tax cuts, tax cuts, tax cuts. Democrats say spend, new programs, more money. You can't spend enough for the Democratic base, or cut taxes enough for the Republican. But in a time when all the grown-ups of America know spending is going to bankrupt us and tax cuts without spending cuts is more of the medicine that's killing us, the same old arguments, which sound less like arguments than compulsive tics, only add to the public sense that no one is in charge

Obama's Trade Deflection

Obama's Trade Deflection

Will he stand up to his own party's protectionists?

Amid the bacchanal that is the Beltway stimulus debate, a rare note of sobriety has sounded. President Obama exercised some leadership on trade this week, and the Senate proceeded to water down the "Buy American" provisions in the House version.

It ain't over until Nancy Pelosi sings, but if the Senate prevails in conference a nascent trade war will have been averted, at least for now. The world is warily watching the new Obama Administration for protectionist signals, after his campaign promises to get tough with our trading partners. Mr. Obama let the House run wild with language demanding procurement rules that clearly violate U.S. commitments as part of the World Trade Organization. That drew protests from Canada, Brazil, Australia and Europe, among other friends of the U.S.

Asked about this on Fox News, Mr. Obama said, "I agree that we can't send a protectionist message." He added that it would be a mistake "at a time when world-wide trade is declining, for us to start sending a message that somehow we're just looking after ourselves and not concerned with world trade."

The Senate followed by amending its earlier draft, which had been even more protectionist than the House. Now the Senate language says "buy American" provisions cannot violate U.S. international agreements.

For a taste of the damage that might have been done, look no further than Brazil. Reacting to the U.S. stimulus proposals, the ministry of development in Brasilia announced that 3,000 new items would be added to the list requiring import licensing. As one source explained to us, this was a "'buy American' provision, Brazilian style."

Brazilian auto makers and the electronics industry resisted the move because they use imported components to maintain their competitiveness. And a brawl broke out inside President Luis Inacío "Lula" da Silva's government. Lula reversed the decision, explaining that he did "not want Brazil being identified with protectionism." That's a sign of Brazil's growing economic and political maturity.

Let's hope the U.S. doesn't go the other way. Even as Mr. Obama was warning against a trade war, Washington state Democrat Brian Baird was lecturing a Brazilian journalist at the annual Davos confab that the world was just "going to have to swallow the [buy-American] clause." This is crude and dangerous politics. Mr. Obama is moving in the right direction on trade, but he's going to have to spend some of his own political capital standing up to the most parochial elements in his own party.

Banks Should Raise Prices in a Recession

Banks Should Raise Prices in a Recession

by Robert P. Murphy

In working on my forthcoming book dealing with the Great Depression, I noticed something intriguing about the discount rate of the Fed. Oh wait, I should first clarify — I'm talking about the New York Federal Reserve Bank, because the Fed banks had more autonomy in the beginning, and so you couldn't talk of "the Fed's" discount rate.

What I noticed is that from the time it opened its doors in November 1914, all the way through 1931, the New York Fed charged its record-low rates at the very end of this period. The "discount rate" was the interest rate the Fed banks would charge on collateralized loans made to member banks. For the New York Fed, rates had bounced around since its founding, but they were never higher than 7 percent and never lower than 3 percent, going into 1929.

This changed after the stock-market crash. On November 1, just a few days following Black Monday and Black Tuesday — when the market dropped almost 13 percent and then almost 12 percent back to back — the New York Fed began cutting its rate. It had been charging banks 6 percent going into the Crash, and then a few days later it slashed by a full percentage point.

Then, over the next few years, the New York Fed periodically cut rates down to a record low of 1 ½ percent by May 1931. It held the rate there until October 1931, when it began hiking to stem a gold outflow caused by Great Britain's abandonment of the gold standard the month before. (Worldwide investors feared the United States would follow suit, so they started dumping their dollars while the American gold window was still open.)

The Fed Hiked Rates During the Depression of 1920–1921

So far my story doesn't sound unusual. "Everybody knows" that the Fed is supposed to slash rates to ease liquidity crunches during a financial panic. It helps to ease the crisis, and provides a softer landing than if the supply of credit were fixed.

But guess what? Throughout the period we are considering, the highest the New York Fed ever charged banks was 7 percent. And the only time it did that was smack dab in the middle of the 1920–1921 depression.

Although you've probably never heard of it, this earlier depression was quite severe, with unemployment averaging 11.7 percent in 1921. Fortunately, it was over fairly quickly; unemployment was down to 6.7 percent in 1922, and then an incredibly low 2.4 percent by 1923.

After working on these issues for my book, it suddenly became obvious to me: the high rates of the 1920–1921 depression had certainly been painful, but they had cleaned the rot out of the structure of production very thoroughly. The US money supply and prices had roughly doubled during World War I, and the record-high discount rate starting in June 1920 was a pressure washer on the malinvestments that had festered during the war boom.

Going into 1923, the capital structure in the United States was a lean, mean, producing machine. In conjunction with Andrew Mellon's incredible tax cuts, the Roaring Twenties were arguably the most prosperous period in American history. It wasn't merely that the average person got richer. No, his life changed in the 1920s. Many families acquired electricity and cars for the first time during this decade.

Why Central Banks Should Raise Rates in a Panic

In contrast, during the early 1930s, the Fed's rate cuts "for some reason" didn't seem to do the trick. In fact, they sowed the seeds for the worst decade in US economic history.

Now let's be clear, I am not merely arguing from historical correlations. There is a perfectly good theoretical explanation for why the record-high rates in the early 1920s were the right policy, while the record-low rates in the early 1930s were the wrong policy. We quote from Lionel Robbins, who wrote from a 1934 vantage point and applied the Mises-Hayek business-cycle theory to the world collapsing before his eyes:

Now in the pre-war business depression a very clear policy had been developed to deal with this situation. The maxim adopted by central banks for dealing with financial crises was to discount freely on good security, but to keep the rate of discount high. Similarly in dealing with the wider dislocations of commodity prices and production no attempt was made to bring about artificially easy conditions. The results of this were simple. Firms whose position was fundamentally sound obtained what relief was necessary. Having confidence in the future, they were prepared to foot the bill. But the firms whose position was fundamentally unsound realised that the game was up and went into liquidation. After a short period of distress the stage was once more set for business recovery.

It's actually easier to see if you forget about a central bank, and just pretend that we were living in the good old days when banks would compete with each other and there was no cartelizing overseer. Now in this environment, when a panic hits and most people realize that they haven't been saving enough — that they wish they were holding more liquid funds right this moment than their earlier plans had provided them — what should the sellers of liquid funds do?

The answer is obvious: they should raise their prices. The scarcity of liquid funds really has increased after the bubble pops, and its price ought to reflect that new information. People need to know how to change their behavior, after all, and market prices mean something.

But in more modern times, thanks not just to Keynes but, more important, to Milton Friedman, central bankers now think that during the sudden liquidity crunch, they are supposed to shovel their product out the door. But in order to do that, of course, they have to water down its potency. It's as if a wine dealer suddenly has a rush of customers for a rare vintage of which he only has 3 bottles, and his response is to put the vintage on sale but then dilute it with 9 parts water to 1 part wine. That way he can sell to all the eager customers and not pick their pocket at the same time.

Now I know there is a big dispute in the Austrian-libertarian academic world over whether banks in a legitimately free market would have 100% hard-money reserves in the vault, or if banks would be allowed to lend out some of their customers' checking-account deposits to other customers. I'm not taking a stand on that here.

What I am saying, though, is that if we decide banks ought to be able to engage in fractional-reserve lending — so that the total supply of credit can be expanded if the banks want to stretch their reserves thinner — then we still agree that the unit price of that expanded credit issue ought to be higher.

If the owner of a trucking company experiences a huge rush for his services, he might decide to postpone essential maintenance on his fleet, to take advantage of the unprecedented demand. But during this period he will be charging record shipping prices to make it worth his while to deviate from the normal, "safe" way of running his business. He will only be willing to bear the extra risk (either to the safety of his drivers or just the long-term operation of the trucks) if he is being compensated for it.

The same is true for the banks. Just as every other business during a recession wants to bolster its cash reserves, so too with the business that rents out cash reserves. If there's a hurricane, the stores selling flashlights and generators should raise the prices on those essential items, to make sure they are rationed correctly. The same is true for liquidity — the moment after the community realizes they are in desperate need of it.

Conclusion

It was a good thing for Americans that Herbert Hoover — regardless of his other disastrous policies — did not want the United States to abandon the gold standard. Because its gold reserves were plummeting, the Fed had no choice but to reverse its disastrous course in late 1931. The next two years were awful, but that was because so much capital had been squandered in the boom and then in the easy-money collapse.

FDR was sworn into office in March 1933. Had he followed the same pattern as Warren Harding and Calvin Coolidge — i.e., had he basically kept the federal government out of it — Americans might have looked back at the Great Interruption, referring to the three-year gap between the Roaring Twenties and the Zooming Thirties.

Switching to today, the sad fact is that Ben Bernanke and the other central bankers of the world do not have any feedback on their behavior. There is no dwindling stock of gold reserves to signal to them that they are doing something horribly wrong. Like all central planners, they are groping in the dark, as Mises said.

Although the dollar is no longer tied to gold, that will not stop the dollar price of gold from exploding when more investors realize that no one, not even a sharp guy like Ben Bernanke, ought to hold the fate of the world's economy in his hands.

Thursday, February 5, 2009

Why 'Stimulus' Will Mean Inflation

Why 'Stimulus' Will Mean Inflation

In a global downturn the Fed will have to print money to meet our obligations.

GEORGE MELLOAN

As Congress blithely ushers its trillion dollar "stimulus" package toward law and the U.S. Treasury prepares to begin writing checks on this vast new appropriation, it might be wise to ask a simple question: Who's going to finance it?

Chad Crowe

That might seem like a no-brainer, which perhaps explains why no one has bothered to ask. Treasury securities are selling at high prices and finding buyers even though yields are low, hovering below 3% for 10-year notes. Congress is able to assure itself that it will finance the stimulus with cheap credit. But how long will credit be cheap? Will it still be when the Treasury is scrounging around in the international credit markets six months or a year from now? That seems highly unlikely.

Let's have a look at the credit market. Treasurys have been strong because the stock market collapse and the mortgage-backed securities fiasco sent the whole world running for safety. The best looking port in the storm, as usual, was U.S. Treasury paper. That is what gave the dollar and Treasury securities the lift they now enjoy.

But that surge was a one-time event and doesn't necessarily mean that a big new batch of Treasury securities will find an equally strong market. Most likely it won't as the global economy spirals downward.

For one thing, a very important cycle has been interrupted by the crash. For years, the U.S. has run large trade deficits with China and Japan and those two countries have invested their surpluses mostly in U.S. Treasury securities. Their holdings are enormous: As of Nov. 30 last year, China held $682 billion in Treasurys, a sharp rise from $459 billion a year earlier. Japan had reduced its holdings, to $577 billion from $590 billion a year earlier, but remains a huge creditor. The two account for almost 65% of total Treasury securities held by foreign owners, 19% of the total U.S. national debt, and over 30% of Treasurys held by the public.

In the lush years of the U.S. credit boom, it was rationalized that this circular arrangement was good for all concerned. Exports fueled China's rapid economic growth and created jobs for its huge work force, American workers could raise their living standards by buying cheap Chinese goods. China's dollar surplus gave the U.S. Treasury a captive pool of investment to finance congressional deficits. It was argued, persuasively, that China and Japan had no choice but to buy U.S. bonds if they wanted to keep their exports to the U.S. flowing. They also would hurt their own interests if they tried to unload Treasurys because that would send the value of their remaining holdings down.

But what if they stopped buying bonds not out of choice but because they were out of money? The virtuous circle so much praised would be broken. Something like that seems to be happening now. As the recession deepens, U.S. consumers are spending less, even on cheap Chinese goods and certainly on Japanese cars and electronic products. Japan, already a smaller market for U.S. debt last November, is now suffering what some have described as "free fall" in industrial production. Its two champions, Toyota and Sony, are faltering badly. China's growth also is slowing, and it is plagued by rising unemployment.

American officials seem not to have noticed this abrupt and dangerous change in global patterns of trade and finance. The new Treasury secretary, Timothy Geithner, at his Senate confirmation hearing harped on that old Treasury mantra about China "manipulating" its currency to gain trade advantage. Vice President Joe Biden followed up with a further lecture to the Chinese but said the U.S. will not move "unilaterally" to keep out Chinese exports. One would hope not "unilaterally" or any other way if the U.S. hopes to keep flogging its Treasurys to the Chinese.

The Congressional Budget Office is predicting the federal deficit will reach $1.2 trillion this fiscal year. That's more than double the $455 billion deficit posted for fiscal 2008, and some private estimates put the likely outcome even higher. That will drive up interest costs in the federal budget even if Treasury yields stay low. But if a drop in world market demand for Treasurys sends borrowing costs upward, there could be a ballooning of the interest cost line in the budget that will worsen an already frightening outlook. Credit for the rest of the economy will become more dear as well, worsening the recession. Treasury's Wednesday announcement that it will sell a record $67 billion in notes and bonds next week and $493 billion in this quarter weakened Treasury prices, revealing market sensitivity to heavy financing.

So what is the outlook? The stimulus package is rolling through Congress like an express train packed with goodies, so an enormous deficit seems to be a given. Entitlements will go up instead of being brought under better control, auguring big future deficits. Where will the Treasury find all those trillions in a depressed world economy?

There is only one answer. The Obama administration and Congress will call on Ben Bernanke at the Fed to demand that he create more dollars -- lots and lots of them. The Fed already is talking of buying longer-term Treasurys to support the market, so it will be more of the same -- much more.

And what will be the result? Well, the product of this sort of thing is called inflation. The Fed's outpouring of dollar liquidity after the September crash replaced the liquidity lost by the financial sector and has so far caused no significant uptick in consumer prices. But the worry lies in what will happen next.

Even when the economy and the securities markets are sluggish, the Fed's financing of big federal deficits can be inflationary. We learned that in the late 1970s, when the Fed's deficit financing sent the CPI up to an annual rate of almost 15%. That confounded the Keynesian theorists who believed then, as now, that federal spending "stimulus" would restore economic health.

Inflation is the product of the demand for money as well as of the supply. And if the Fed finances federal deficits in a moribund economy, it can create more money than the economy can use. The result is "stagflation," a term coined to describe the 1970s experience. As the global economy slows and Congress relies more on the Fed to finance a huge deficit, there is a very real danger of a return of stagflation. I wonder why no one in Congress or the Obama administration has thought of that as a potential consequence of their stimulus package.

Mr. Melloan is a former deputy editor of the Journal's editorial page.