Yes, the stock and bond markets cratered last week on fears that the economy is running too hot for the Fed. Like other elite institutions that occupied the economy's commanding heights during the post-World War II era, the Fed is losing some of its power to millions of investors and their portfolio decisions. Simply put, the bond market's fixed-income investors won't stand for a sustained resurgence in inflation. In fact, they've become a powerful regulator for ensuring price stability as rates rise and fall in anticipation of changes in the general price level. Even more telling for long-term investors, the bond market may be signaling a far more optimistic economic story than the current turmoil suggests.
Interest rates are high, after taking inflation into account.
The investment boom has companies competing fiercely for financing. The soaring demand for credit has sent real rates higher, since rising real rates is a credit-market mechanism for allocating capital to the most productive ventures. Don't let another inflation scare in the market distract you from the fundamental transformation of the U.S. economy and the power of the markets. On that score, James Carville got it right. The McGraw-Hill Companies Inc. All rights reserved.