- The Washington Times - Tuesday, April 25, 2000

When the core consumer price index registered a .4 percent monthly gain (4.9 percent annualized) earlier this month, hoards of analysts, newspaper writers and media mavens rushed to proclaim a new era of troublesome inflation. Based on this view, Pavlovian portfolio managers sold heavily into a falling stock market. For a brief period, panic prevailed.

All this came despite the fact that the year-to-year trend CPI hit only 2.4 percent. Really, this is a high-class problem compared with the double-digit inflation pace of the 1970s that impoverished the economy and destroyed the stock market. In those bad old days, very few economists believed the nation would ever see an inflation rate as low as 2.4 percent.

Actually, if we knew with certainty that the inflation rate would average 2.5 percent per year for the next decade, then we would all be quite satisfied and would invest steadily in the stock market. Supply-sider Victor Canto posits that a 3.5 percent economic-growth rate, a 2.5 percent inflation rate, coupled with a 6 percent long-term Treasury yield, could gradually move stock market price-earnings ratios to 35 or 40. This would be consistent with something like a 35,000 Dow. Pretty good scenario, don't you think?

As for the CPI itself, none other than his eminence Alan Greenspan downgraded it during his talk to the New York Economics Club last winter. Instead, the Federal Reserve chief suggested watching the personal-consumption deflator (PC), which he said is a "far more sophisticated and accurate measure" of inflation than the CPI.

The personal-spending deflator, where consumer patterns are updated each quarter, really is more reliable than the CPI. The CPI weightings, however, are based on spending recorded in 1993-95. Neither index, by the way, truly captures the technology-induced price-cutting effects of the new economy.

In the March CPI report, for example, personal computers fell 2 percent in the month, recording a 23.3 percent decline year-on-year. But the paltry PC weighting of one-tenth of 1 percent is substantially less than it should be. Telecommunications price cuts and software deflation are essentially unrepresented.

As I've argued before, inflation is not caused by a bunch of individual price rises. Nor is inflation caused by too much growth or too low unemployment, as the headline writers loudly asserted last weekend.

Only a steady depreciation of the dollar causes recurring inflation in other words, a monetary phenomenon. But in terms of the dollar's value on foreign exchanges (about 106 for the dollar index), and its buying power in relation to gold ($280), there is strength, not weakness. This signals price stability, not roaring inflation.

Excess liquidity created by the Fed would cause the dollar to slump. During the second half of last year, the Fed poured in high-powered base money at a 24 percent annual rate, compared with only 8 percent growth in transactions-demand money as represented by the measure MZM. Both of these monetary aggregates are published weekly by the St. Louis Fed.

In the new year, however, the Fed has been draining reserves. This is illustrated by a 16 percent year-to-date drop in the annualized growth of the base. MZM transactions demand has been steady, growing at 7.5 percent annually. So what the Fed gaveth last year, to guard against Y2K shocks, they are takething away this year.

This liquidity drain has brought gold prices down from a peak of $325 last year, and it has also helped bring long-term Treasury yields down from around 6.8 percent early last January to below 6 percent today. King Dollar continues to sit on its throne.

So if there is any small inflation upturn from last year's liquidity excess, it will be brief in duration and nearly insignificant in its economic and stock market impact. Along with the end of tax-deadline selling, the recovering stock market seems to be realizing that price stability is here to stay.

And let's not forget the productivity-enhancing effects of rapid advances in technology. This vital new economy theme is ever-present and ever-powerful. Tech stock prices will fluctuate and churn, but the economics of technology innovation are pro-growth and anti-inflation. This is one reason why recent profit reports are so strong.

Long-term investing is still the wisest course. This is not the 1970s.



Lawrence Kudlow is chief economist of CNBC.com and Schroder & Co., Inc.

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