All ‘flation (inflation/deflation) is not created equal.  @santellirants correctly diagnosed the mistake of aggregating consumer price inflation with asset price inflation recently when frustrated over “economic semantics.”  The importance of appreciating the nuances of this issue cannot be overstated.

Its implications are crucial for domestic economic policy.  Understanding that consumer prices are increasing at an unacceptable rate is a vital issue to comprehend in crafting optimal monetary, fiscal, and “non” (i.e free markets unencumbered by intervention and regulation) policy.  Consumer prices are too high relative to wage growth and fundamentally-justifiable asset (e.g. equities and real estate) price growth.

Too many folks are looking at aggregate data and making policy prescriptions based upon data that is not optimal for decision making.  I believe most folks personally feel consumer prices are increasing.

Is your cost of living (yes, I know you are living better each year, so feel free to make a personalized hedonic adjustment; but let’s remember that one can’t eat an iPad) going up by only a negligible or non-existent amount each year?

Click to View(http://www.advisorperspectives.com: Click on Chart to Enlarge)

Do you know anyone who says “Wow, I’m so happy everything is cheaper this year?”  Did you ever hear anyone say that even in ’09?

Not everyone owns stocks.  I am happy for folks who have made money in the stock market since ’09, in part due to monetary policy implemented in hopes of unleashing the wealth effect.   However, that is not the optimal way for the entire economy, including the people who made money since in ’09, to prosper.

stock_wlf(http://www.washingtonpost.com/blogs/wonkblog: Click on Chart to Enlarge)

Having an efficient economic system is the key for everyone to earn solid wages and a reasonable return on capital.

 “The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.”

Henry Hazlitt (Yes, I am aware that many folks despise Hazlitt, but this quote is a good one, regardless of what you think of him otherwise)

“Ok, Jon, how do we transform the system without breaking it?  It’s so fragile!”  I am aware.

By normalizing monetary policy, everyone is freaked out aggregate demand will go through the floor.  The below changes will serve as the golden substitution regarding aggregate demand in the economy.

And, oh yeah, it will be fairer because the tax system more directly affects everyone than the stock market.

We need tax reform.  By lowering marginal income tax rates for everyone, we encourage more income to be earned which, by the way, is a good thing.

The 10% corporate tax rate in my proposal sounds low, but it is optimal.  Many large companies with the best lawyers often don’t pay that rate anyway because of loopholes, etc., but I am confident no one will legitimately complain about loophole elimination if the rate is lowered to 10%.

image(Click on Chart: http://online.wsj.com/ “More U.S. Profits Parked Abroad, Saving on Taxes”)

Most importantly, companies can start paying the corporate tax to America (instead of countries with lower corporate tax rates) and feel free to deploy capital here (and, in doing so, employ people in the US) if we lower rates to an acceptable level.

(Click on Chart: http://www.cato.org/blog/corporate-tax-rates-cnns-narrow-sample)

In addition, the increased cash in the economy through the effects of the tax cuts will help ensure a smoother interest rate normalization process than pure tapering of the quantitative easing (QE) program.

The short-term pain will be averted, and the longer-term structural problems will begin to be addressed.  Even @billmaher has complained about taxes being high, so I don’t want to hear taxes aren’t high enough.

“How are we going to pay for all of these lower taxes, Jon?”

Well, we should be asking the same thing anyway with current monetary policy.  Despite what some might think, QE ain’t free.  Off-balance sheet debt is all fun and games ’til a currency goes kaput.  Fortunately, we don’t have that potential issue as a major current concern.

Though, @forexlive gave the opinion this morning that $100B+ in QE purchases per month (currently at $85B per mo) might disrupt the dollar market.  It should, but the US has time to get it right if we begin to improve our policy framework.

I don’t hear many folks praising Europe’s current fiscal situation and, accordingly, it is a miracle the euro is this high.  Don’t get me started on the yen.  As for gold, I’m sick of hearing about it.  And neither it, nor any fiat (i.e. paper) currency, is liquid enough to replace the dollar for a while.

“How can it be that easy, Jon?!”  We are lucky.  The US has, most likely, at least 5-10 years before the subsidized purchasing power it gets from the world (as epitomized in the currently-ludicrous 10 yr TSY rates at 1.69%) for being the reserve currency is at risk of being lost.

If we get our finances in order then we can continue to enjoy the free purchasing power that comes from having our PAPER reserve currency being our chief export. 

I don’t know too many people that want to start having a lower standard of living, so let’s get on it.

Related Reading:

@Matthew_C_Klein: Is the Federal Reserve Insane?

@Jesse_Livermore: “More expansionary fiscal policy plus tighter monetary policy is the clear answer right now”