- The Washington Times - Sunday, May 21, 2006

Once again, Wall Street’s most feared boogeyman, inflation, spooked the markets at a time when just about everything except oil was going up: manufacturing and retail sales, job creation, corporate profits and the best inflation-fighter of all — productivity.

Ironically, the market’s sharp decline last week occurred when the price of oil — the principal culprit in the latest inflation report — was dropping from the $73 to $74 a barrel to about $68. Longer-term, gasoline reserves were rising for the third week in a row (a sign of lower gas prices to come), as gold, seen as a hedge against inflation, fell.

If all this leaves the typical buy-and-hold investor a little confused, you weren’t alone. Wall Street seemed bewildered by it all, too. Wednesday’s 214-point plunge in the Dow and sell-off in the broader markets was characterized by a mass of contradictions.

If oil futures were falling as supply exceeded demand, that’s a sign inflationary pressures will ease.

Another sign of lower inflation in the months to come was the cooling in the economy. No one believed it could keep up the torrid pace of the last year. Gross domestic product is moderate, though still strong. The overpriced housing markets were cooling, too, as sales fell from their hyperbolic highs.

Both these indicators were clearly anti-inflationary signals. The free market to a large degree seemed to be readjusting itself. Add to that the always-intense price competition that is the driving force in the economy, and that old Inflation Monster doesn’t look as scary as some would have us believe.

Besides, it’s never wise to make any policy decisions based on one-month’s data. The Labor Department’s report that the consumer price index rose by 0.6 percent in April (about 4 percent over the last three months) was fueled primarily by rising energy costs that had, as expected, filtered through the economy.

Still, once the volatile energy and food sectors are removed, the core inflation rate remained modest, rising 0.3 percent last month, identical to the March rate. In the last 12 months, the core rate has been 2.3 percent.

Even so, Wall Street is fixated on what the Federal Reserve will do to interest rates in light of all this and what that will mean to stocks. The Fed may continue pushing rates higher. This worries investors who fear it will push lending rates higher, which will in turn slow the economy, weaken growth and reduce earnings, and that will sandbag stock values.

No one knows what the Fed will do under Chairman Ben Bernanke’s leadership at its next meeting in June. But we do know from the minutes of the previous meetings that the board is getting worried about going too far. The minutes show a growing concern among Fed governors that the rate increases they approved, which lag six months in their effect, will overshoot inflation targets and undermine future growth.

Mr. Bernanke reflected these concerns in his testimony before Congress last month when he said the central bank could decide at some point to leave rates unchanged — despite some signs of lingering inflationary risks.

The board’s fear of excessive tightening should be a comforting signal to Wall Street, but will the Fed act on it? Maybe there should be a sign in the center of the large oval table in the Fed’s ornate meeting room reading, “First, do no harm.”

My own view is that inflation won’t worsen, the cooling of the economy, particularly the housing markets, will intensify competitive pricing and businesses will continue tightening costs to increase their bottom line.

Another development will give the stock market and the economy a big boost in the months to come: That is Congress’ extension of the 2003 capital-gains and dividend tax cuts that President Bush signed last week. A 15 percent maximum rate (I think it should be zero) will further fuel this market once we get over the bearish jitters that have seized what I think will remain a bull market.

Historically, stock markets do not perform that well in midterm election years, and we may see more volatility until the elections determine Washington’s political direction. But I think the fundamentals in the U.S. economy remain strong and that the expanding global economy long-term will boost growth in our exports, which will be good for jobs, profits and investors. Look for the total economy to grow to $13 trillion by next year and for the Dow to surpass 12,000 by year’s end.

Remember, anyone who bets against the American economy will lose.

Donald Lambro, chief political correspondent of The Washington Times, is a nationally syndicated columnist.

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