- The Washington Times - Friday, July 19, 2002

You most likely heard Alan Greenspan chastise fraudulent accountants and corrupt corporate leaders during hearings this week on Capitol Hill. But in addition to his "infectious greed" tongue-lashing, our Fed chairman gave a fairly upbeat assessment of the economy, with the central bank actually raising its economic growth targets for this year and next.

This is important for a number of reasons, not the least of which is the obvious undervaluation of the stock market relative to the rising economy and improving profits. With steady long-term interest rates in place, the major index averages are 30 percent to 40 percent too cheap right now.

Another important insight gleaned from the Maestro is that the Fed is likely to move the key fed funds interest rate up and not down which means Mr. Greenspan sees this economy heating up although that move will not occur until the winter or spring of next year.

As usual, Mr. Greenspan made no mention of the Fed's primary function which is to create money. Literally, that's just what the central bank does. It creates new greenbacks that will be put in circulation, as well as new bank reserves that will bolster the liquidity of the financial system. For some reason, he never talks about this openly although Wall Street would love to hear his take.

Judging by recent trends, the Fed has been accommodative to economic expansion, although less so in light of some headline bankruptcies (such as WorldCom). Credit markets have tightened a bit in response to these falling asset values, shrinking market caps, sinking investor wealth and eroding bank-loan portfolio quality. And the central bank could have done a little more.

Nevertheless, the Fed has been injecting new money into the system at an appropriately rapid 11 percent yearly pace, compared to roughly 5 percent a year ago. Consequently, gold and commodity prices have moved higher, signaling an end to deflation. Presumably the Fed will keep increasing its rate of cash creation and monetary-base expansion for another six to nine months. On the whole, Fed monetary policy is currently pro-recovery.

And although the media don't seem to recognize it, that's just what we're doing: recovering.

In recent days, a gangbuster increase of the index of industrial production went virtually unreported. But this is arguably the best gauge of the current health of the economy. With a June rise of eight-tenths of 1 percent, industrial output in the U.S. has grown nearly 6 percent at an annual rate over the past three months. And within that number, high-tech output is moving ahead at a 27 percent rate. Even business-equipment production has increased slightly over the past two months, the first back-to-back rise in cap-expenditures in quite some time.

After 6.1 percent annual growth in first-quarter gross domestic product, the second quarter could grow as much as 3.5 percent, based on the strengthening trend of industrial production.

Believe it or not, the technology sector that has been utterly trashed by the stock market is growing rapidly right now. Semiconductor production is rising at better than 40 percent per annum and information-processing equipment is spiking by nearly 5 percent (compared to a 20 percent decline last September). Meanwhile, old economy industrial equipment (or non-high-tech) is increasing by nearly 10 percent. These are big numbers. They suggest business-recovery skeptics are being proven wrong.

Of course, there are glitches in the optimistic scenario. There always are.

As Congress moves to deal with corporate corruption and accounting fraud, over-regulation becomes an economic threat. Some regulatory cost increases may be a necessary evil, but this could be offset with regulatory reductions especially paperwork reductions if legislators are interested in promoting economic growth.

Tax reforms, such as those suggested by former Reagan advisor Richard Rahn, could also help the corporate recovery. Ending the limited tax deduction on executive compensation would remove the incentive for stock-option grants that create harmful short-run stock-price boosting. Tax-deferred stock grants, held for the duration of employment, is a better idea.

Dividend payouts, meanwhile, could be made all or partly tax deductible, putting them on the same tax footing as interest payments. More dividends are credit-enhancing measures that confirm to investors that plenty of spare corporate cash is in the bank. This would also create an incentive to reduce the large overhang of corporate debt, which has been a big problem for investors.

Outright corporate tax-rate reduction would aid U.S. businesses in competing internationally, too. Right now, out of the top 30 industrial countries, we are the 24th worst corporate taxer. This is not good.

Or how about a turnover approach to capital gains, whereby stock sales that are soon reinvested would not be treated as taxable events. This would provide much-needed new oxygen for the contracting blood vessels of capital formation and spur a recovery in the stock market.

Additional accounting oversight, more ethical corporate behavior, more independent company governance, and full enforcement of existing laws are necessary to restore worldwide confidence in U.S. business. But lawmakers should recognize that business expansion and employment growth are the ultimate goals.

So far the Fed is doing its job. Can we say the same for Congress?


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