- The Washington Times - Thursday, January 13, 2000

Stock prices roared after the release of the 315,000 jobs increase report last Friday, despite the chorus of economic sopranos that predicts rapid-fire Fed moves to raise the key fed funds policy rate by 75 to 100 basis points. How can this be?
In the Internet economy, rising productivity and profits are more important than the Fed. Inside the jobs report was another modest 3.7 percent yearly rise in average hourly earnings. By inferring strong profits, this triggered the stock rally. Well before Monday morning's announcement that AOL is taking over Time Warner.
If the latest Fed theory about "scarce labor resources" were really true, wages should be soaring. After all, if the supply of something is less than its demand, then prices will rise. Basic microeconomics, or price theory.
But the price of labor is not soaring. This is because its supply is still adequate in relation to its demand. Fed officials who doubt this are forgetting about the roughly 10 million who are still unemployed nearly four years' worth of workers.
Also, immigrants and college graduates continue to refill the labor pool. In fact, most job-takers are better educated than job-leavers. Better educated also means more productive. And where education is lacking, American companies both large and small have instituted significant job training programs. That's why it's a great country.
This whole "scarce labor resources" argument is nothing more than the Phillips Curve in drag. It's transsexual economics. Everything is upside down. Meaning no disrespect, but it doesn't work for most people.
Growth doesn't cause inflation. Neither do too many people working, producing or prospering. Last quarter growth was nearly 6 percent. But inflation was just above 1 percent.
Actually, rapid growth is the key to understanding why inflation is virtually non-existent. The availability of more goods and services absorbs the existing money supply. More money chasing even more goods. That is why King Dollar still reigns and the gold price is still low. Both are signaling price stability. There is no excess money.
One of the lesser understood spillover benefits of the Internet economy is the high rate of investment return that increases the economy's capacity to grow. Therefore, it reduces the economy's inflationary potential. More goods are counterinflationary.
Productivity of course is central to this story. Overall non-farm productivity is trending around 3 percent. For the non-financial corporate sector, the trend is nearly 4 percent. In manufacturing, the trend is more than 5 percent.
So, less than 4 percent wage growth leaves unit labor costs, or productivity-adjusted wage costs, at just about zero. For old economy smokestack, manufacturing and basic materials, labor costs are actually falling.
Rock-bottom costs from moderate wages and rising productivity are the key to rising profits. S&P; earnings-per-share will probably rise close to 20 percent in 1999 and only slightly less in 2000. This is more important than a few interest rate nicks from the Fed.
If actual core inflation reports this week come in way above expectations, then the Fed should tighten policy in early February. I have no problem with that. Really, in that scenario, they ought to tighten immediately that very day.
But I have a hard time envisioning this outcome because commodity price indicators have flattened. Even oil is showing weakness. Once the Y2K-related repos run off, monetary base growth (true money supply) will be about equal to MZM and M2 growth (true money demand).
Message to Fed: Leave well enough alone. Go slow. Wait and see. Remember, enough interest rate increases and the economy will slow markedly.
That's the real risk. Too few goods chasing too much money. History shows that maximum inflation risk occurs with minimum economic growth. A slowdown in goods will bring on a speed-up in prices. It is this scenario that is manifestly to be avoided.

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

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