- The Washington Times - Monday, May 15, 2000

For all those Phillips Curvers who believe low unemployment and rapid economic growth cause inflation, and are therefore screaming from the rafters for a 100 basis point Fed tightening in May and June, last week's retail sales report should provide a wake-up call. The economy is slowing more than you think.
Be careful what you wish for, all you old economy pessimists. These are the weakest sales numbers in a long time. Not just the overall figures, but inside the totals there is even more weakness.
For example, general merchandise sales have eased down to 7.4 percent growth over the past 12 months, much weaker than the 9.7 percent total retail sales rise, and the slowest since late 1998. Department store sales are even weaker, rising by 6.6 percent over the past year, compared to their 8.5 percent peak in late 1998.
Over the most recent three-month period, general merchandise rose by 5.6 percent at an annual rate, with department stores increasing only 3.9 percent. So, there's a major slowing trend in the works.
Add this evidence to the clear slowdown in the housing sector, as well as a modest growth reduction in private business investment, and you have early but significant evidence the new economy is losing steam.
Back to retail sales. The BTM leading chain-store sales index has been predicting a major drop-off in consumer spending for quite some time. In fact, this index is predicting zero growth over the next 12 months.
So far this year actual consumer demand has exceeded the BTM leading index by a considerable amount. However, there may be two special factors that have delayed the projected slowdown.
One is the Y2K effect, where consumers spent heavily last autumn and winter in anticipation of Y2K shortages. That spending surge, however, was probably borrowed from likely consumption over the next 12 months.
Additionally, a lot of stepped-up consumer buying has occurred in order to beat future interest rate hikes. Accelerated spending nearly always accompanies Fed rate increases; buy now, beat tomorrow's higher financing costs.
But the temporary stimulus effects of Y2K and accelerated spending ahead of future Fed rate increases are wearing off. This is why consumer spending is likely to slow quite a bit in the months ahead.
Based on our models, overall real GDP growth in the next four quarters is predicted to slow to 3 percent, compared to 5 percent growth over the past year. Rising interest rates and falling liquidity do matter. Lags are long and variable, but tighter money will depress the economy, even the new economy.
What is more, if there is so much inflation developing out there, then why is the gold price moving toward $275, and why is King Dollar so strong at above 111 on the index? Over the past 5,000 years, carefully compiled empirical data show clearly that a rising currency value is associated with price stability, or even deflation, but certainly not inflation.
Mind you, I don't care one whit if people are spending and consuming. It is a free economy, and a free country, and if folks feel like spending like crazy it's OK by me.
But I can't buy into this Fed argument that folks are consuming faster than businesses are producing. Or that we have reached the limit on production. Industrial capacity utilization is only 81.4 percent.
Even more, the 3.9 percent unemployment rate still leaves roughly 13 million able-bodied people out of work, according to Labor Secretary Alexis Herman. "In the midst of this debate over interest rates," she said, "we must keep the focus on the nation's strong productivity to absorb any pressure on wages."
President Clinton hailed the low unemployment rate by calling it "a triumph for the technology economy." He pointed to the social benefits of strong growth, where Hispanic unemployment has dropped to 5.4 percent and black unemployment to 7.2 percent. Both of these are the lowest jobless rates in many decades.
I agree with Mrs. Herman and Mr. Clinton. Full employment is something to be desired, not opposed. At a Manhattan Institute gathering a while back, Robert Mundell argued that full employment can be maintained without inflation so long as the dollar is strong. He called it "crawling along the ceiling."
Tight money and slowing retail sales suggest to me there is no need for aggressive new Fed restraint. Next thing you know the unemployment rate will start to rise. The stock market is already having enough trouble pricing in the impact of prior Fed moves on future earnings growth.
So my first choice is that the central bank do nothing tomorrow. Of course, that won't happen because the monetary priests are obsessed with stock market wealth creation and low unemployment. So my second choice is a 25 basis point Fed funds rate increase.
The trick for monetary policy-makers is to look through the front-view windshield, not the rear-view mirror. Their efforts to fine-tune the economy have already caused enough instability. They have re-introduced the business cycle. Let's not make it any worse than it needs to be.

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

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