- The Washington Times - Tuesday, September 17, 2002

A year ago, most economists predicted a long and deep recession following the terrorist bombings in New York and Washington. They were dead wrong.

Instead, last year's third quarter marked the end of a yearlong recession that began in 2000. This recession was caused principally by a prolonged period of monetary deflation, which wiped out share prices, corporate balance sheets, profits and capital-goods investment.

Since last fall, the free-market, resilient and productivity-enhanced U.S. economy has rebounded at a 3 percent annual rate. This may be a below-par recovery, but it's still way better than the economic situations in Europe or Japan.

The post-September 11 recovery is marked by lingering deflation and a stubborn corporate credit crunch on the negative side of the ledger, and housing spike on the positive side. Housing has really saved the day. Roughly 70 million people own their own homes today, and collateralized borrowing and refinancing against these price-appreciating assets has provided significant and much-needed movement of money through the economy.

Over the past three quarters, key economic performance measures show solid, if unspectacular, recovery rates. Real gross domestic product has increased more than $200 billion for a 3 percent annualized growth. Real consumer spending has advanced by $173 billion, or 3.6 percent. After-tax personal income adjusted for inflation has gained $163 billion, or 3.2 percent. Corporate profits for domestic industries have grown by $121 billion, or 31 percent. Industrial production has advanced by slightly less than 2 percent annually. And factory shipments have grown by nearly 5 percent.

What's more, inflation remains nil and interest rates have fallen across the board meaning the economic environment remains, in large part, accommodative to growth and investment.

So, with all these positive recovery factors showing up, why haven't we witnessed a recovery in stocks, which appear to be significantly undervalued? For the first time in interplanetary history, a recovery in stocks is lagging a recovery in the economy. What gives?

Money gives. The biggest single concern at this stage of the recovery is the absence of sufficient liquidity to finance businesses and a stock-market recovery. Corporations want and need fresh cash to cover large debt accumulated prior to the recession, and risk-averse investors are not bailing them out.

If the Federal Reserve understood this, they would be pumping high-powered cash into the economy at a minimum 10 percent annual rate. However, in the past six months monetary-base growth has slipped to 6 percent annually from a 14 percent pace in the prior period.

As I've pointed out before, the way for the Federal Reserve to get the money moving where it's needed is to deregulate the fed funds rate basically, the Fed should let the key interest rate rise and fall naturally as the market dictates. If this were the case now, the fed funds rate would drop, allowing the Fed to buy back tons more Treasury bills. The Fed would pay for that purchase with newly created high-powered cash that would flow to the corporations in need.

An investor tax-cut package would also aid this recovery. Right now, investors are penalized at nearly every turn, which is no way to draw more money into the stock market. Terminating or at least reducing the double taxation of dividends would give investors more incentive to buy stock. It would also incentivize corporations to pay out dividends, which could be taxed at the same 20 percent personal rate as capital gains. Balance sheets would gradually be restructured away from debt and toward equity, signaling improved cash flows and corporate creditworthiness.

Such an investor-friendly tax package could be rounded out with an increase in the capital-investment loss deduction, a tax-free turnover of reinvested stocks, and higher limits for supersaver 401(k)s and IRAs. Each of these reforms would also promote saving and investment.

If the Bush administration proposes such an approach, it would provide a very positive jolt to the economy and the stock market. Even if an investor-tax-cut package doesn't pass both houses of Congress the likely scenario it would still tell investors where the Republican Party stands on stock-market growth.

The Contract With America successfully illustrated party differences on a wide range of issues in 1994, and the GOP routed the Democrats in midterm elections that year. In similar fashion, a Republican-backed Contract With Investors might well provide Commander In Chief George W. Bush with sufficient legislative majorities in both Houses to promote growth-related domestic security at home and national security overseas.

Economic strength at home leads directly to military strength abroad. Ronald Reagan understood this well. George Bush has an opportunity to follow in the Gipper's path.

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