- The Washington Times - Friday, March 2, 2001

In the political game of expectations this past week, President George Bush's quasi-State of the Union message on tax and budget policy passed with flying colors. But Fed Chairman Alan Greenspan flunked in his monetary report to Congress.

President Bush steadfastly and artfully defended his pro-growth tax-rate relief plan, along with a flexible freeze budget and a move to ease energy drilling and production rules in order to generate more power for the high-tech wired economy. In sum, Mr. Bush put forward a clear economic growth strategy to reverse the Clinton economic decline he has inherited.

Mr. Greenspan, however, had no such message. After considerable speculation that the Fed chairman would significantly revise the economic report he delivered two weeks ago to the Senate, and great market hopes of a 50 basis-point inter-meeting rate cut, the so-called maestro vetoed the early rate cut idea and altered his testimony only slightly, but pessimistically.

In response, stock markets fell again. And again. The bear market Nasdaq technology index, already down more than 50 percent from its peak, is now joined by the S&P; 500, which has recently moved into the official bear territory of a 20 percent decline.

The stock market message is a recessionary one. And Mr. Greenspan said very little to rebut this outcome. He no longer disputes that the sizable drop in consumer confidence is consistent with past recessions. He also believes that "excesses built up in 1999 and early 2000" are still causing a "retrenchment" in the economy.

Reading between the lines, Greenspanspeak is essentially saying that a recession is upon us, and there's really not much the Fed can do about it. Yes, the central bank will cut interest rates more in the months ahead. But they prefer to do so at regularly scheduled FOMC meetings, rather than in between meetings.

The next Fed policy get-together is March 20, with future meetings scheduled for May 15 and June 27. It is not unreasonable to anticipate 50-basis point cuts in the Fed funds policy rate at each of these meetings. That would bring the key rate to 4 percent by mid-year.

However, there is a cost to delaying these rate cuts. Think of it this way. If you know there's a deep discount car sale starting one week from now, will you shop for a new auto this coming week?Or will you wait to capture the price-cut benefits of the official sale?

The same holds true for the economy. Since everyone in our well-informed Web site economy knows that future Fed rate cuts are in the cards, they are likely to hold back on spending and investing actions until the Fed actually pulls the trigger.

Hence, delayed interest rate cuts will actually have the unwanted effect of delaying economic recovery. The Fed may believe it is acting prudently in an orderly manner by holding back until its formal policy meetings occur, but the unintended consequence of this thinking will cause a lengthier downturn in the short run.

The exact same principle holds for tax policy. That is why President Bush has wisely asked Congress for a retroactive tax-rate cut and prompt legislative action to trigger it. Delaying or phasing in tax cuts will slow the economy in the short run.

This is particularly the case for upper-end earners, who supply much of the risk capital for new business investment. Why declare a transaction when the top rate is 40%, when you know in a year or two (or six) it might be 33%? Risk capital will be withheld until investors can capture the lowest marginal tax-rate. But it's the provision of risk capital that truly drives the animal spirits of growth.

Back to Mr. Greenspan. He continues to avoid any responsibility for the economic downturn. Instead, he puts the finger on mistake-prone business people who accumulated too many inventories, or crazed technology entrepreneurs who committed too much capital, or overly exuberant stock market investors, or nasty OPEC countries who jacked up oil prices.

Everyone's to blame but the Fed. But how about the inverted Treasury yield curve most of last year, which was signaling excess Fed tightening and warning of a future recession? How about the wild go-and-stop money supply policy, where 12-month monetary base growth swung from 6.6 percent in December 1998 to 16 percent in December 1999, and then collapsed to negative 2.5 percent by December 2000?

Even today, the central bank refuses to acknowledge that virtually every commodity price on the planet is deflating. Or that the short end of the Treasury curve is still inverted, where three-month Treasury bills yield more than two- and five-year Treasury notes.

These commodity and financial price indicators suggest that liquidity preferences in the economy are very high (retail and institutional money funds are growing like topsy), but the Fed's provision of liquidity is still in short supply.

Economic growth is not likely to resume until liquidity is adequate and the Treasury curve is upward sloping from the short end all the way out to the longest dated maturities. Commodity prices and interest rates will have to stabilize before confidence returns.

Easier money and lower tax-rates is an appropriate monetary-fiscal policy mix to stimulate recovery. And help is on the way. But it now looks like delaying tactics from the Fed will postpone a likely stock market and economic rebound for several more months.

Lawrence Kudlow is chief U.S. investment strategist and chief U.S. economist at ING Barings LLC.


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