On the supply side.

MAIN STREET loves it, but international currency markets and Wall Street do not. What is it? An economic boom that will last throughout this year and may well spill over into 1995. It is not sustainable, and it will generate considerably higher inflation and a nasty economic downturn when the cycle runs its course, probably in 1996. But in the meantime, 1994 will turn out to be a much stronger growth year than nearly all the experts predicted.

To begin with, most Americans owning or working in businesses believe the recent news on strong job creation is grounds for optimism. April produced 265,000 new non-farm payroll jobs, after a stunning 464,000 new hires in March. About a million new hires in March. About a million new jobs were generated during the first four months of 1994.

What's more, Main Street realizes that, for whatever reasons, the U.S. economy has entered a boom phase. After growing less than 2 per cent annually from the end of 1988 to the end of 1992, the economy over the past four quarters has accelerated markedly: 3.6 per cent for real GDP growth, and 5.5 per cent for private real GDP growth.

Not only a boom, but a industrial boom. While the East and West Coasts are still lagging, the middle of the country, including the natural-resource- and commodity-producing Rockies, is experiencing its best times since the late 1970s. Business investment spending has surged 17 per cent over the past year, while machine-tool orders are up 21.6 per cent. Industrial production has increased 5.1 per cent since last April, including a 10.8 per cent rise in the production of business equipment. As a leading indicator, unfilled-order backlogs of capital goods (excluding the volatile defense and aircraft sectors) have jumped at a 21.6 per cent annual rate over the past three months, suggesting that the boom will continue at least through year's end.

Much of the Main Street boom can be traced to the cheap dollar, which already this year has dropped 10 per cent against the Japanese yen and 5 per cent against the German mark. In fact, over the past three years the dollar has lost 50 per cent of its value against the yen. This currency protectionism has virtually shut Japanese and German manufacturers out of U.S. markets.

U.S. automakers are especially happy campers. With the overpriced yen, Japanese competitors are losing sales and market share, and domestic auto production has increased 18.7 per cent over the past year, and at a 48 per cent annual rate in the first quarter. Meanwhile the yearly selling rate has skyrocketed to 21.3 per cent, while inventories are relatively low. Tried to buy a jeep or minivan lately? There are only 59 selling days of "light truck" inventories on dealer lots, compared to 75 days a year ago.

But it is precisely the exchange-rate imbalance that has caused so much turmoil in world currency markets, centered on the sinking Clinton dollar, which is reminiscent of the Carter dollar 15 years ago. In his first 15 months, Treasury Secretary Lloyd Bentsen cooperated with confrontational trade negotiators Mickey Kantor and Ron Brown by hinting to the rest of the world that the U.S. would accept a lower dollar to offset a growing trade imbalance.

Of course, Mr. Bentsen's Republican predecessors, James Baker and Nick Brady, also supported a lower dollar. Indeed, it was Mr. Baker's public bickering with Germany in the summer of 1987 that led directly to the global stock-market crash that October.

World investors, businesses, and entrepreneurs vastly prefer stability to volatility where money is concerned, but since President Nixon ended the Bretton Woods system in 1971-73, currency volatility has been the rule. Except for a brief interlude (1981-85) under President Reagan, the dollar has come under sporadic attacks for the better part of over twenty years.

Now the trade deficit has grown worse, and a new dollar crisis appears on the horizon. Mr. Bentsen has changed his stripes and publicly called for intervention to stabilize the greenback's value, but as of this writing the Fed has not backed up the new policy with decisive action--i.e., raising the discount rate from 3 per cent to 4 per cent. An indecisive 0.5-percentagepoint rise would likely do more harm than good.

The current situation cannot be blamed solely on the U.S., however. Japan has been deflating its economy for three years, keeping real-estate interest rates way too high, monetary base growth much too low, and pulling the yen price of gold down by a staggering 37 per cent. Over the past year wholesale prices in Japan have declined 3 per cent, generating the worst recession since the mid 1970s.

That said, the U.S. and Japan must sit calmly at a negotiating table to realign exchange rates and monetary and trade policies before the world experiences another scary stock-market collapse. Not only because the dollaryen relationship is so far out of line, forming the nexus of the G-7 problem, but also because a further sinking of the dollar could sharply undermine economic recovery all around the world. The dollar is still the world's reserve currency, and emerging freemarket countries everywhere have essentially adopted the dollar as their principal means of exchange and investment store of value.

From Russia, through Central Europe, to Mexico and South America, and spreading through Hong Kong and the other Asian Tigers, including China, governments and new business enterprises and humdreds of millions of people own dollars. If the greenback's value sinks, so may those who depend on it.

The problem can be solved if Japanese and U.S. authorities simply update the Bretton Woods golden anchor. Gold is currently at $385 an ounce; the dollar should be appreciated so that gold could be rebased at $350 (ten times the old $35 par value). Moreover, since most economists agree the dollar should purchase at least 125 yen, the Japanese yen should be depreciated about 15 per cent to roughly a 43,500 yen price of gold. To establish the new gold points, the U.S. must sell dollar Treasury bills while Japan must purchase dollars, preferably in the forward market. This would make dollars more scarce and yen more abundant.

U.S. bond traders hate the current situation because they see that the quantity of U.S. dollars created by the Fed remains overly abundant. That is why gold and commodity prices, including copper, silver, lumber, oil, and coffee, are mounting yet another rally, while stocks and bonds continue to sag. Indeed, bonds are in their biggest freefall since the late 1970s. Investors are rearranging their portfolios out of paper money and into hard assets (including real estate) as a hedge against inflation.

Take a look at the expansion of the Federal Reserve's balance sheet, especially the series called Federal Reserve Bank credit, which shows the amount of loans made and securities purchased by the Fed. This is the best indicator of central-bank money creation, what Milton Friedman many years ago called high-powered money. Since late 1991, when yearly Reserve Bank credit was rising at a well-controlled 4 per cent pace, this measure of monetary stimulus accelerated to 8 per cent by year end 1992, then 12 per cent in 1993, and so far in 1994 it has been holding around 11.5 per cent. In other words, very easy money.

The problem is not growth or prosperity, it is bad money. Even worse, the current problem is bad money and higher taxes. In the short run, easy money dominates by stimulating aggregate demand. In the long run, however, higher taxes exert a drag on the supply side of the economy. We have seen not only the largest tax hike in peacetime history, passed in 1993, but the threat of more taxes in 1994 should Congress pass new entitlements for health care, welfare reform, and job training. As the effects of lowinterest-rate policies wear off, the taxbrake will prevent the economy from supplying necessary goods.

Along with advance-warning inflation signals from gold and commodity price increases and the recent auto price hikes, the number of purchasing managers reporting higher prices has moved to 34 per cent, the highest in three years. A recent Wall Street Journal/NBC News poll found that 50 per cent of respondents expect higher inflation, suggesting that Main Street also sees the problem. The producer price index jumped at a 3.9 per cent annual rate in the first quarter, while the crude materials component (excluding food and energy) is now 10.9 per cent ahead of its year-ago level.

If the Fed is to make money properly scarce, interest rates will have to rise much more in the next year than either Main Street or Wall Street expects. The Fed has not yet begun to tighten; it is merely following an 11 per cent first-quarter rise of bank loans to businesses. As a rule of thumb, the growth of nominal GDP (total spending in the economy) should be roughly in line with 3-month Treasury bills if inflation is to be held in check. Currently, nominal GDP growth is trending toward 7 per cent, so the prevailing 4 per cent Treasurybill rate may have to rise by as much as 300 basis points over the remainder of 1994 and into 1995. Failing this, inflation could rise to 5 or 6 per cent.

What most people seem not to understand is that a significant interestrate rise will not affect the economy for 12 to 18 months. While inflation will pick up this year, its full impact will not be felt until 1995-96. Therefore, if we assume that the economic boom and the interest-rate rise may not peak until the first half of 1995, then the damage may not be fully felt until 1996, when the economy slumps badly while inflationary pressures linger on. In terms of presidential economics, Clinton is peaking too soon. Unlike President Reagan, whose economic growth policies peaked in 1984 without inflation, the Clinton team has completely mistimed the cycle, much as the Carter team did. Republicans will be on the defensive this fall, but a strong dose of recession and inflation in 1996 may yet save the GOP from itself.