In today’s Wall Street Journal (subscriber content), hedge fund manager Andy Kessler says that long-term economic performance would be greatly enhanced if the Fed would back off its free money strategy, and increase interest rates.  He’s correct.

Why?  Because the Fed is doing nothing about now except queering up the usefulness of money as an indicator of value.  When the price of the money dramatically changes, the value of all those things that are priced in money becomes nearly impossible to discern. 

Kessler claims increasing interest rates would yield a 20-30% drop in commodities prices.  I’d say it would be more like 50-60%.  The whole story of commodities prices is inflation.  As I have repeatedly discussed, commodities like oil, wheat, cotton, corn and copper, are not increasing because of expanding demand or because of crimped supply.  There’s been little change in aggregate demand and supplies are ample, even with a few poor harvests here and there, even with Libya’s oil output disruptions.  To paraphrase, it’s the money, stupid.

Would unemployment increase if the Fed raised interest rates?  Indeed, short-term unemployment rolls likely would increase, but not because the Fed’s artificially low money is prompting sustainably higher employment levels.  The Fed’s free money has created the illusion of expanded demand and its inflationary policies have made relative wage rates decline, so employment has expanded a bit over the last six months, but not sustainably.  Illusions never are sustainable.  Unemployment would initially increase when rates go up because wages would no longer be declining on a real basis due to inflation, and to get sustainable increases in employment, wage rates have to decline while demand also expands.  Once a difficult period of adjustment passes, when both demand and wages finally hit bottom, the economy can then sustainably increase employment and output.  As things are now, the period of adjustment is only in delay, as asset bubbles are being inflated, awaiting some trigger to pop them, after which the whole edifice comes crashing down, again. 

There is little risk to the economy with increasing interest rates.  Continuing along the path of zero-priced money will soon enough yield either stagflation of epic proportions that yields a similar adjustment period just described, or asset bubbles that get popped and end just the same.  Increasing interest rates now means getting the pain over with now, so that economic growth can sustainably proceed sooner. 

The problem with the Fed’s policy is not just that it is ineffective, though it is that.  Money machinations do not real outcomes determine.  The problem with the Fed’s policy is that it will eventually impair economic performance simply because it makes determining real value an ever-more time-consuming and complicated task.  The main use of money is to communicate value, and if the Fed destroys or severely impairs the functioning of money as a price and value communicator, economic performance will suffer.

Kessler’s right.  Raise interest rates now.