- The Washington Times - Monday, September 10, 2001

Economic recovery is just around the corner, if you're to believe leading officials at the Federal Reserve, the Treasury and the White House. By "recovery," they mean a 3 percent growth rate next year, with high expectations that clear rebound evidence will surface during this year's fourth quarter. But judging by the continued stock-market plunge, the public is not buying what the government is selling.
This has been one of the worst summer stock markets in recent history. The much-heralded summer rally never materialized. In fact, despite repeated Fed rate cuts and a federal consumer tax rebate, the technology-driven Nasdaq has lost another 25 percent of its value in the past three months, with the broader S&P; 500 index dropping 15 percent.
Traditionally, stock markets are a leading indicator of the economy. When markets began hemorrhaging last summer and fall, they correctly signaled the onset of a business slump. This has happened many times in economic history. Going back 20 years, during the early Reagan administration, national economic gloom was punctured by a big stock-market rally in the second half of 1982, which correctly heralded the long prosperity boom.
But it's not happening now. Actually, applying a normal six- to nine-month lead time, stock markets are beginning to signal that no recovery will occur until the second half of next year.
Investor spirits and business confidence continues to sink. A daily drumbeat of bad earnings reports has overwhelmed the stock markets. Some of the numbers are startling: Semiconductor profits are off 85 percent; telecommunications are down 72 percent; durable-goods makers are off 77 percent — all for the second quarter. Leading surveys now predict an incredible 67 percent additional drop in technology profits for the third quarter and perhaps another 40 percent drop in the fourth.
The real message coming from the equity market is that the economy is getting worse, not better. Undoubtedly, some of this pessimism springs from a rather looney-tune debate in Washington, where leading Democrats are ranting over dwindling budget surpluses, virtually foreclosing any hope of additional and much-needed tax-cut stimulus. Al Gore's old lockbox for Social Security trust funds has resurfaced. And the Bush administration, which is favorably inclined toward business tax cuts, increasingly finds itself boxed in by Social Security scare tactics.
But there are signs of sanity in Washington. Dan L. Crippen, the head of the Congressional Budget Office, testified that "the attention given to what's in the Social Security trust fund come 2015, or even if the trust fund exists at that point, is misplaced," adding that "the payroll taxes will have no changes due to the president's tax cut." Then, in the most sensible statement to come out of Congress on this debate, Mr. Crippen noted, "What will matter is the size of the economy."
Bravo. Mr. Crippen for president, or Fed chairman, or something. The size of the economy and its ability to grow is the absolute key point that is being ignored in this dreary, Herbert Hoover-like budget debate.
While the Bush tax cuts passed by Congress are a move in the right direction over the long term, in the short run they are having little or no effect. Retailers around the country are reporting virtually no evidence that the tax rebates are boosting sales. Even more to the point, the nation is faced with a supply-side business downturn, not a consumer demand-side decline. It's as though the government economic doctors, having made the wrong diagnoses, are now prescribing the wrong remedy.
On the monetary side, the Fed is finally ending its scorched-earth deflation by cutting interest rates and expanding the money supply, which will propel aggregate demand, not supply. Yet the collapse of business investment, production and profits is a supply-side — or investment-side — problem. The right remedy would be across-the-board tax reform to boost work effort and capital formation through lower tax-rate incentives on individuals and businesses.
But the tax-rate reduction in the Bush plan doesn't kick in for five years. And with Democrats ranting over the holy budget surplus, the chance of true business tax relief — including measures such as capital gains and accelerated depreciation allowances — are minimal.
The Fed, the White House and the Treasury should heed the message of the real-world stock market. It is clearly telling us the economy could be much worse, and that the role of government policy should be much more stimulative on both money and taxes. A combination of supply-side tax cuts and greater Fed stimulus will grow the economy, protect Social Security, increase long-term budget surpluses and preserve America's role as world leader.
The sooner Washington comes to its senses, the faster economic recovery will begin.

Lawrence Kudlow is a nationally syndicated columnist.

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