From the peak last Monday, to the close last Friday, the Dow Jones Industrial Average fell 5.3%, the NASDAQ tumbled 5.5% and the S&P 500 slid 4.3%.

Some blame rising delinquencies in the US sub-prime loan market, while others blame China for attempting to slow down its supposedly overheating economy and markets. These explanations fit snuggly into the widespread belief that investors have underestimated risk and become complacent. Alan Greenspan's use of the R-word last week also fed a fear that the current recovery is long in the tooth and trouble may be looming.

The fact that Alan Greenspan is worried about a recession is somewhat ironic. One of the major issues facing the economy today is the aftershock of the rollercoaster the Fed forced the economy to ride beginning in 1999.

The Fed lifted rates too high in 1999 and 2000, causing a recession and deflation. It then cut rates too much in 2001, 2002 and 2003 in an almost panicked response designed to keep deflation from spreading. Because of those rate cuts, deflation did not spread, but a federal funds rate of 1% led to a rapid expansion of credit - especially in the housing market.

Now that the Fed has lifted rates 17 times, and pushed the funds rate back to 5.25%, those who over-leveraged in the midst of extremely low interest rates have found themselves in trouble. These credit problems are not because interest rates are too high today; they are the result of absurdly low rates of the recent past. This is important because most recessions occur when the Fed tightens too much and causes liquidity problems to spread.

But the Fed is not too tight, it's just less loose. In fact, inflation is still on the rise and both our top down macro-models and our bottom-up estimates of weekly data, continue to point to 3% real growth in the first quarter, despite a below trend February employment report. Fear is the market's problem, not the economic fundamentals. Stocks are still cheap.

Posted by Brian Wesbury at 12:30 PM | Email Author | Permalink

German economic growth ended 2006 on a high note. Real GDP grew 3.7% in 2006, the fastest growth rate in more than 15 years, more than twice as fast as the 1.7% growth rate of 2005, and significantly above the identically disappointing 0.2% real growth rates of 2002, 2003, and 2004.

The acceleration of growth in 2006 caused many forecasters to become more optimistic about Germany, and some even began to predict an economic renaissance in Continental Europe. After years of sub-par performance, this would be welcome.

But all this excitement appears misplaced. On January 1, 2007, the German VAT tax was raised from 16% to 19%, while the top marginal income tax rate increased to 45% from 42%.

The knowledge that these tax rates would rise in 2007 created an incentive to bring income and spending forward into the lower tax year. For Germany, this means that growth was stolen from 2007, which artificially boosted economic activity in 2006.

Early data for 2007 on consumer and business confidence show a reversal from the positive news of 2006. Both industrial production and factory orders fell in December, and January retail sales are weaker than at any time since early 2004.

While the consensus has settled on a German real GDP growth rate of 1.5% to 2.0% for 2007, we suspect that this is overly optimistic. The European Central Bank is running what we would call a neutral monetary policy and the German government is planning a reduction in corporate tax rates in 2008. In other words, there will be an incentive to push income and profits from 2007 forward into 2008.

Germany remains a very high tax economy. The top marginal income tax rate is 45%, social security taxes are 19.9%, health care payroll taxes are 14.3%, while unemployment insurance is 4.2%, and corporate tax rates are roughly 40% (when local taxes are included). These high tax rates suggest the surge in 2006 economic activity was nothing but one-year wonder.

Posted by Brian Wesbury at 02:30 PM | Email Author | Permalink

The personal saving rate was negative 1% in 2006 (equal to negative $92 billion), the second straight negative year and the lowest since at least 1947. What this means is that for every $100 in after-tax "income," US consumers spent $101. To some, this proves that Americans are living beyond their means and that calamity is virtually assured unless something changes.

We could not disagree more. The so-called personal saving rate is a highly misleading indicator of the consumer balance sheet. Other, much better measures show that the American consumer is in excellent financial health.

To calculate the personal saving rate, government statisticians subtract taxes and spending from personal income. Income includes wages, salaries, interest, dividends, rent received, small-business profits, and some government benefits. Excluded are withdrawals from IRAs and 401ks, as well as capital gains. This is inconsistent with how most people measure their private fiscal health.

For example, a retiree with no wage (or other) income, who withdraws $40,000 each year from her IRA to spend on living expenses, would drag down the savings rate. Or, as Bear Stearns economist David Malpass pointed out, the $30 billion in appreciated Berkshire Hathaway stock Warren Buffett has pledged to the Gates Foundation was never counted as income. But when that money eventually gets spent it will count as consumption and reduce "personal saving."

A basic problem with the often quoted personal saving rate is that it mixes together current workers with retirees who should be expected to spend much more than they earn. One academic economist has calculated that excluding retirees from the figures would add about 4 percentage points to the saving rate. Moreover, this error should grow over time as the US ages and healthcare costs (a major purchase for retirees) continue to grow.

Another problem with the saving rate is that when consumers buy durables - think cars, furniture and appliances - the spending is counted right away even though payments will be made over time. Amortizing these purchases would push up the saving rate another 2 percentage points. Interestingly, despite this treatment of durable goods, the government does subtract housing depreciation from income. And because home prices have climbed dramatically in recent years, depreciation has climbed. In 2006, this depreciation subtracted $226 billion from saving - it did not affect consumer cash flows, but pushed the "official" saving rate into negative territory.

In the end the saving rate, as it is currently calculated is a useless measure of household balance sheets. A much better measure of true savings is the net worth of households, a statistic calculated by the Federal Reserve. As of September 2006 (the latest data available) US households had $54 trillion more in assets than liabilities, an all-time high. Moreover, total net worth had increased by $3.5 trillion from the year before. If this $3.5 trillion increase in net worth were used as the appropriate measure of personal saving, the saving rate was 37% last year and has averaged 33% the past ten years, a far cry from the "negative saving rate" which so many pessimists decry.

Posted by Brian Wesbury at 01:45 PM | Email Author | Permalink

This week, Federal Reserve Board Chairman Ben Bernanke goes to Capitol Hill to give his semiannual testimony to Congress. Many members of Congress seem ready to grill him about the economy in general. Newly elected Ohio Senator, Sherrod Brown said, "While the economy is good for people at the top, it's not so good for a steelworker in Lorain, Ohio, or a small-business owner in Dayton. I'd like to hear a recognition from [Bernanke] of that and what he's going to do about it."

This is an interesting question. It gets to the heart of what monetary policy can and cannot do. We have no idea how Chairman Bernanke will answer it, but a truthful answer would not give much satisfaction to Senator Brown.

While many people think the Federal Reserve controls interest rates, and some even think the Fed controls the entire economy, in reality, the Fed only controls one policy tool - the amount of money circulating in the economy.

By adding money to, or subtracting money from, the US banking system, the Fed can impact the economy in the short-term, and influence the level of interest rates. But printing money creates no lasting wealth. If it did, counterfeiting would be legal and no nation on earth would experience poverty.

The number one job of monetary policy is to keep the value of money stable - balancing money supply and demand. If the Fed supplies too much money, inflation climbs and the dollar loses purchasing power. If the Fed allows the money supply to contract, (as it did in the 1930s) it causes deflation. Neither of these is good. A stable currency creates the best environment for conducting business and building long-term wealth.

Judging the perfect monetary policy is not an easy task. This is where the Fed creates problems for itself. For years, the Fed has suggested that a low unemployment rate and rising wages signal inflationary pressures. Then when the Fed tightens to fight those issues, it creates an anti-prosperity appearance, often infuriating congress.

A much more meaningful and appropriate signal of impending inflation can be found in low real interest rates, rising commodity prices and a declining value of the dollar. These signals indicate an excess supply of money.

It is fiscal policy that has the most impact on economic growth, jobs and incomes. In this regard, keeping tax rates low, regulation to a minimum, and markets free provides the most potential to increase living standards for all.

Posted by Brian Wesbury at 03:29 PM | Email Author | Permalink

This story from Romney's home town Boston Herald, on the back of his big pro-tax cut speech to the Detroit Economic Club yesterday, is exactly the kind of news the former Massachusetts's governor does not need at this stage in his campaign.

After refusing to endorse President Bush's tax cuts when he was governor, Mitt Romney has now made them a central part of his presidential campaign, stirring accusations that he is changing his position to appeal to GOP primary voters. In 2003, Romney stunned a roomful of Bay State congressmen by telling them that he would not publicly support Bush's tax cuts, which at the time formed the centerpiece of the president's domestic agenda. He even said he was open to a federal gas tax hike.

This report flies directly in the face of Romney's economic address yesterday, and subsequent interview on CNBC with Larry Kudlow, and is only going to reinforce a building image of an overly ambitious man who is a serial flip-flopper on core issues.

Posted by John McIntyre at 06:57 PM | Email Author | Permalink

If you think the offensive production of Peyton Manning and the Super Bowl Champion Indianapolis Colts was spectacular, you ain't seen nothing yet. When January budget data comes out this week, our models predict that tax revenues continued to surge and the federal budget will show a surplus of more than $40 billion.

This would pull the budget deficit on a 12-month moving average basis below $200 billion for the first time since September 2002 - a massive reduction from the peak deficit of $455 billion in the 12-months ending April 2004.

Tax revenues were $2.479 trillion in the 12 months ending in January 2007, a $255 billion increase from the 12 months ending in January 2006. Tax revenues have surged for almost three consecutive years now, ever since the tax cuts of 2003 stimulated a strong economic recovery.

But putting points on the scoreboard is not a guarantee of victory. The defense has to play well too. And for the budget this means spending restraint. Federal spending was $2.667 trillion in the 12 months ending January 2007, a $134 billion increase from the 12 months ending in January 2006.

On a 12-month versus 12-month basis, federal revenues increased 11.5%, while federal spending increased just 5.3%. This is great news. As long as spending growth remains in check, the budget deficit will continue to decline.

In fact, our models expect average tax revenue growth of 9% over the next three years and spending growth of between 4% and 5%. This will generate a well below consensus deficit in FY07 of just $115 billion. Next year in FY08, we forecast a deficit of only $35 billion. On a 12-month basis, we suspect that the budget will move into balance early in FY2009, well before the Office of Management and Budget or the Congressional Budget Office expect.

All of this is fabulous news for the markets. With gridlock holding spending back and the economy continuing to generate spectacular revenue growth, earlier than expected budget surpluses will significantly reduce the odds of tax hikes.

Posted by Brian Wesbury at 09:30 AM | Email Author | Permalink

The history of semiconductor manufacturing is peppered with one amazing story after another. The industry has overcome issue after issue to make chips smaller, faster and cheaper. Lately, insulation has become so thin that electricity leakage has been a real issue. But, once again, a solution is at hand.

Intel and IBM claim to be on the verge of manufacturing semiconductors with new metallic alloys. These new chips will have faster processors, but use less energy - an advancement that will allow cell phones (and other devices) to do more demanding tasks (e.g. play videos) with less battery drain.

This type of progress is symbolic of the entire New Era Economy. Productivity is booming. And rapid productivity growth explains why corporate profits, jobs and income growth have all accelerated at the same time.

Some forecasters have refused to accept this explanation and for the past few years have argued that rising oil prices, a housing slowdown, or some other calamity would bring the economy down very soon. These "fragile-economy" forecasters just can't shake their pessimism.

Others have called this a Goldilocks Economy, because productivity not only pushes growth up, but pulls inflation down. What could be better than high growth, low inflation and low interest rates?

But there is a third view, which argues that much like the story Goldilocks, the bears of inflation and higher interest rates are on their way home.

Despite rapid increases in productivity, the Cleveland Fed's weighted-median CPI (a measure which excludes the impact of big and small price increases) is up 3.7% during the year-ended December 2006. This is a sharp acceleration (a near doubling) from the 1.9% YOY growth rate in January 2004. While productivity helps contain prices, if monetary policy is too accommodative, inflation can still rise.

The fragile-economy crowd is too pessimistic on growth, while the Goldilocks crowd is blind to the inflation that is already here. The market, however, has recently pushed interest rates up sharply (the 10-year is up 44 basis points) and begun to price in greater odds of Fed rate hikes. The price of gold is back above $640/oz., and the dollar remains weak.

One last point: Inflation does not result from job creation, rising wages or strong growth, it's caused by "too much money chasing too few goods." Hiking interest rates a few more times to quell inflationary pressures will not hurt our high-productivity economy. Not hiking interest rates would be the real mistake and a very sad development when the Fed is on the verge of getting it just right.

Posted by Brian Wesbury at 04:30 PM | Email Author | Permalink

Fed chief Ben Bernanke strolled up to Capitol Hill yesterday and scared the pants off Congress and the American public. His message? An over hyped, doom and gloom forecast about an entitlement bankruptcy tidal wave slamming American shores.

Unfortunately, Mr. Bernanke and all the other pessimists are using low-ball economic estimates to make their alarmist case.

As far as Social Security is concerned, a set of optimistic (yet eminently reasonable and realistic) economic assumptions exist which lead to no bankruptcy and no trust fund exhaustion.

This scenario--one rarely discussed by most--includes slightly less than 3 percent real economic growth, and 2 percent productivity per year. Over the next seventy-five years, this solid growth forecast keeps the Social Security funds alive and well.

(Bear in mind, real GDP growth over the last fifty years has averaged 3.3 percent annually. Why would people assume the future will be the worse than the past?)

Bernanke's gloomy bankruptcy assumptions--where the trust fund is expected to exhaust in 2040--rely on a rather uninspiring economic outlook of around 2 percent growth. This is rubbish. With low tax rates, high productivity and low inflation, our technology based economy is poised for a long cycle of prosperity.

These doom and gloom Social Security scenarios aren't worth the paper they're printed on.

The real problem with Social Security is not bankruptcy. It's the dreadful investment return (barely 1 percent) that future retirees have to look forward to.

If Americans had the chance to purchase S&P 500 SPDR contracts, and were able to hold them for fifty years, they would receive a real return of at least 7 percent compounded annually based on the history of the stock market. That's a lot of Benjamins. Heck, even if workers were given a lousy bank deposit option, federally insured by Uncle Sam, they could still count on squeezing out at least 3 percent compound returns.

The real reason we need to reform Social Security is to give American workers a far better retirement nest egg than the current system is capable of providing--not because of some phony bankruptcy driven deficit scenario.

Did someone say personal savings accounts?

Let's remember that more savings means more investment. This in turn leads to productivity-fueled growth. The end result is we have more revenues to pay off Social Security liabilities over the next seventy-five years and vastly more wealth for retirees.

Think of it.

Posted by Lawrence Kudlow at 12:49 PM | Email Author | Permalink

For almost four years, a pessimistic pall has generated forecasts and press reports suggesting that the economy is due for a substantial slowdown, perhaps even a recession. Some of these forecasts finger the "housing bubble," oil prices, or debt loads as the catalyst. But, lately, the number one crutch of the pessimists is an "inverted yield curve" - the fact that short-term interest rates are higher than long-term rates.

On one point, the pessimists are right: the yield curve has inverted before every recession in the past 40 years. But a closer look at past episodes of inversion and recession suggests that today's economy is different. Our models indicate very low odds of a recession and continue to point to strong economic activity throughout 2007.

The current inversion is different because it has occurred with low short-term interest rates. Our measuring stick is nominal GDP growth (real GDP growth plus inflation). Whether short-term interest rates are above long-term interest rates is not as important as whether short-term rates are above the trend growth rate of nominal GDP. Think of nominal GDP growth as the ability of the economy to repay its loans. If interest rates are lower than the growth of the ability to repay, that's okay; if interest rates are higher, that constrains future living standards.

Simply comparing short-term rates and long-term rates does not answer the question of whether short-term rates are high or long-term rates are low. And that question has to be answered because the economic effects of high short rates and low long rates are not the same. High short-term rates represent tight money, which leads to slower economic growth. Low long-term rates do not harm the economy. If the yield curve is inverted because long-term rates are low, then that's just another way for consumers and businesses to borrow without hurting their future standard of living.

Past inversions of the yield curve occurred when monetary policy was very tight and short-term rates were high. There have been six recessions since 1961, and prior to each of them the yield curve inverted when the federal funds rate rose at least one full percentage point above nominal GDP growth, and 4.5 percentage points above the inflation rate.

Today, the federal funds rate is well below these trigger points. Nominal GDP growth has been 6.26% in the past two years, a full percentage point above the current 5.25% federal funds rate. Meanwhile, the federal funds rate is just 3 percentage points above "core" inflation. By either measure - nominal GDP growth or inflation - short-term interest rates are not too high. The driving force behind the inverted yield curve is low long-term rates, which are not something to worry about.

This helps explain why the economy remains strong. ShopperTrak RCT - a Chicago-based company that monitors foot-traffic and sales at retail outlets across the country - calculates that Christmas-season sales were up 5.1% versus 2005. This healthy gain is not statistically different from last year's 5.4% increase when the yield curve was normally sloped. It's hard to find any signs that the economy is anywhere near crumbling under the weight of excessively high interest rates.

Posted by Brian Wesbury at 01:29 PM | Email Author | Permalink

When Chris Petersen, head football coach of the Boise State University Broncos held up the Fiesta Bowl trophy after his team's amazing victory over The University of Oklahoma last week, he said, "This is for the Bronco Nation."

That was understatement. The Boise State Broncos had just done what many people thought impossible. And they did it in a way that electrified the entire nation, not just Boise fans.

It was quintessential Americana. Call me weird, but I could not help thinking about the Revolutionary War. The British Army believed gentlemen fought in lines, on wide-open ground, 50 or so yards apart, slowly loading and firing muskets at each other. While the regular army participated in many of these types of battles, the irregulars and militia fought more of a guerilla-style campaign - attacking supply lines and ships.

Likewise, Boise State's very solid team augmented its offense with guerilla tactics, including an impossibly perfect hook and ladder pass play to tie the score, a quarterback in motion and an absolutely stunning Statue of Liberty running play (for 2 pts.) which sealed the victory, and a 13-0 record.

Bob Stoops, the head coach of Oklahoma stood shaking his head on the sidelines after every one of these plays, much like British General Charles Cornwallis must have done after being defeated at Cowpens by General Nathanael Greene, and before surrendering to the upstart Americans at Yorktown.

Old line football stalwarts, like Nebraska, Ohio State, Alabama, Notre Dame, and Michigan rarely try trick plays - for two reasons. First, they don't believe it's necessary because their system and recruiting should make victory a high probability. And, second, they are risk averse (Notre Dame tried a fake punt in its bowl game last week and failed, most likely angering and embarrassing many alumni).

But risk-taking made America what it is today - the largest and most dynamic economy on the face of the earth. Young, upstart, entrepreneurial companies - the underdogs - typically drive the process. Yesterday's GM, Ford and IBM are today's Google, Apple and Microsoft.

This does not mean that old-line companies don't create wealth and provide a solid base for the American economy. They do. But risk-taking entrepreneurs provide the real vibrancy because they don't need to be defensive. The free market encourages innovation and creativity and every day there is a playoff in the marketplace.

There are certainly institutions and laws in place that protect the status quo and make it harder to compete against established companies. In much of continental Europe these protections are widespread and stifling. But in American business, anything can still happen, just like on the football field. It's called freedom and it works.

That's why a playoff to find the Division I College football champion should take place. If Florida beats Ohio State tonight, in a football match-up decided on by committee, not by head-to-head competition, the Boise State Broncos will be the only undefeated team in the nation. If Ohio State wins, then there will be two undefeated teams. Either way, the Broncos will never get a shot. For the "Bronco Nation," for the entire nation, the NCAA should institute a playoff for Division I college football as soon as possible. It's the American way and it's the only way to name a true champion.

Posted by Brian Wesbury at 03:39 PM | Email Author | Permalink

The number is out: another 167,000 payroll jobs created in December.

Posted by Tom Bevan at 08:14 AM | Email Author | Permalink

Brian Wesbury, the chief economist with First Trust Advisors, has a great column in today's Wall Street Journal on the American economy the last quarter of a century.

You. In 1982, Time magazine's Person of the Year was a machine--the personal computer. Twenty-four years later, after being empowered by the computer, the 2006 Person of the year is-- "You." Time's cover sports a small mirror so we can contemplate ourselves--the controller of the information age--and think about all our blogs, pages on MySpace or Facebook and videos on YouTube.

The most interesting thing about this progression is that it did not result from consumer demand. Demand does not create wealth. Consumers were not marching in the streets 30 years ago complaining about the fact that there was no way to share their daily activities and innermost thoughts with thousands of their closest friends. People were not begging for personal computers, email, broadband, the Web, or blogs. Entrepreneurs, futurists, scientists and the very early adopters birthed this technology: Today's average consumer was either clueless or still in diapers.....

In the early 1980s, tax rates were cut, government interference in the economy was reduced, and the Fed followed a tight money policy. As stagflation was cured, entrepreneurs got to work. In garages, basements and cinderblock buildings, today's technology promptly came to life even before its full usefulness was understood. It took more than a decade for the Internet and email to become real consumer products. It was the supply of this technology that fueled its growth, not the demand for it.....

If France had chosen to cut tax rates, regulation and the size of its government in the early 1980s while the U.S. continued on its path towards a social welfare state, it would be the French who would be complaining about excess corporate profits and the income gap. Americans, on the other hand, would fret about a 10% unemployment rate and march in the streets demanding job guarantees and shorter workweeks.

While Iraq has dominated the political headlines and was certainly the driving force behind the Democratic takeover of Congress in November, the current good economy won't continue uninterrupted forever. The reality is at some point the U.S. will face another recession (perhaps sooner than we think) and there is an increased risk from a political standpoint that the rise of populism and the increase in Dobbsian rhetoric has the potential to undo many of the pro-growth economic policies of the last 25 years that have provided the foundation for America's economic success the last quarter of century. The danger becomes a normal run of the mill recession provides the political fodder for a step backward toward economic polices that sound good to the public in 30 second sound bites but lead to stagnation, high unemployment and ironically worse living standard for the lower and middle class workers the polices are supposedly intended to help.

Posted by John McIntyre at 02:09 PM | Email Author | Permalink

The ISM manufacturing index beat the street rising to 51.4 percent in December, up from 49.5 percent in November.

This is very good news. Economists were expecting the index to remain below 50 percent at 49.5 percent. (Anything north of 50 signals expansion.)

Production and new orders both increased, while prices fell.

What used to be called the Purchasing Manager's Index is now called the Institute of Supply Management. It's one of the best real-time economic stats out there--not from the government, mind you, but from private manufacturing businesses.

On another note, President Bush's op-ed today in the Wall Street Journal argues that his tax cuts fueled economic growth while simultaneously spurring record tax revenues. The bottom line? The budget deficit has plunged while the economy has soared.

Think of it as the Bush Boom--think of it as another "W" in the win column for supply-side economics and the Laffer Curve.

At lower tax rates, economic behavior responds with more work and greater investment. Our expanding economic pie throws off more tax revenues, even at these lower tax rates.

In his op-ed, Mr. Bush also pledged to clamp down on budget spending and corrupt earmarks. He's aiming for a balanced budget plan by 2012. (I think it could happen sooner). He asks the Democratic Congress for bipartisan cooperation but if not, he clearly threatens to use his veto pen.

Good plan, President Bush.

Posted by Lawrence Kudlow at 10:31 AM | Email Author | Permalink

The overall economic growth rate did not suffer greatly from 9/11 - consumer spending was higher in October 2001 than it was before the attacks. Nonetheless, an increase in perceived risks caused a series of long-playing and somewhat dramatic developments to unfold over the past five years.

On the very micro-level, cucumber sorbet was out, while pecan pie and bread pudding were in. A little bit up the food chain, so to speak, airline travel and hotel stays plummeted in the wake of 9/11, but consumers spent more on their homes and motor vehicles - comfort food types of investment. Even further along the pipeline of economic activity, business insurance costs soared, which led to a dip in investment and non-residential construction. This dip occurred despite the Fed's decision to drop interest rates even more sharply in the aftermath of the attacks.

Now, more than five years later, the economy is still reeling from many of these decisions. After gorging on houses and autos when interest rates were low and the appetite for risk was suppressed, these markets are now satiated. While we reject the idea of bubbles, it is clear that absurdly low interest rates (1% federal funds rate and 0% auto-financing) turbocharged these markets and stole future growth from these sectors.

Moreover, the risk aversion induced by terrorism also pulled equity prices into undervalued territory and pushed bonds (which many view as less-risky investments) into overvalued territory.

But now, comfort food is giving way to what many might call more risky fare. Housing is clearly in decline and autos are struggling, but the stock market is climbing steadily. At the same time, airline travel is at new record highs and there is a shortage of hotel rooms in many markets.

While no investment is truly risk free, aversion to risk has allowed corporate profits to more than double over the past five years without a commensurate increase in stock prices. And despite recent strength, the S&P 500 remains 25% to 30% undervalued.

Weakness in housing and autos is not bad news for equity investors because weakness in these comfort food markets is not a result of a squeeze in liquidity. The Fed is not tight, it is just less loose. Interest rates are still low, liquidity is plentiful and the results will be tasty.

Posted by Brian Wesbury at 12:30 PM | Email Author | Permalink

On Tuesday, the World Institute for Development Economics Research of the United Nations University (UNU-WIDER) released a study called "The World Distribution of Household Wealth".

The study's headline, from their press release, begins "the richest 2% of adults in the world own more than half of global household wealth". The next two paragraphs of the press release read as follows:

The most comprehensive study of personal wealth ever undertaken also reports that the richest 1% of adults alone owned 40% of global assets in the year 2000, and that the richest 10% of adults accounted for 85% of the world total. In contrast, the bottom half of the world adult population owned barely 1% of global wealth.

The research finds that assets of $2,200 per adult placed a household in the top half of the world wealth distribution in the year 2000. To be among the richest 10% of adults in the world required $61,000 in assets, and more than $500,000 was needed to belong to the richest 1%, a group which -- with 37 million members worldwide -- is far from an exclusive club."

Much further down in the document is a discussion of the "Gini value", a measure of income or wealth inequality, in which the authors say "The study estimates that the global wealth Gini for adults is 89%. The same degree of inequality would be obtained if one person in a group of ten takes 99% of the total pie and the other nine share the remaining 1%."

Although researchers at institutions like the UN have done a much better than usual job of avoiding obvious political bias in this study, the same can not be said for the media. A typical example comes from Reuters (a story which was picked up on web sites from the UK to Australia), in which the reporter's story line goes roughly like this:

• 2% of adults own more than half of global wealth
• wealth distribution is "even more skewed" than income
• the "pie share" story, i.e. one person in a group of 10 having a dollar and the other 9 having $99 dollars
• Then she picks up this quote: "The super-rich are even more grotesquely rich than 50 years ago."

As if her bias against wealth were not already obvious, she then takes the information showing that it is not hard (by western standards) to be in the top percentiles of wealth by doubling the $500,000 threshold in the press release and saying "a couple in 2000 needed $1 million in capital to number among the richest 37 million people in the world, the top 1 percent." (And of course she leaves out what even the study's authors noted: that is "far from an exclusive club."

It is only two-thirds of the way through the Reuters article that the writer points out that wealth of $2,200 gets you into the top half of the world's population. The only good thing I can say about the Reuters reporter is that at least she is not the India's Economic Times editor who branded those people in the top percentiles of the world's asset holders as "the filthy rich".

What writers like the Reuters reporter are doing (intentionally, I believe) is trying to get readers to infer massive wealth differentials within their own countries whereas this study is about the differences among countries.

But let's dig into this study a little more.

The United States has 25% of the world's wealthiest 10%. Japan has 20%. Germany, Italy, the UK, and France have 8%, 7%, 6%, and 4% respectively.

In terms of population as a percentage of world population, here are the numbers: USA 4.57%, Japan 1.95%, Germany 1.26%, Italy 0.89%, and the UK and France both at 0.93%.

In other words, when asking what percent of these industrialized nations' populations are in the top 10% of wealth, the results look like this: USA 18%, Japan 10%, Germany 16%, Italy 13%, the UK 16%, and France 23%.

(Keep in mind that the wealth statistics are for adults only and the population numbers include children, so differences in reproduction and immigration in years preceding the study data make the relative values above slightly different given that Japan has a low rate of reproduction, the US a fairly high rate, and most of western Europe in between.)

[Because of exchange rate issues, the Japan number is smaller than I would have expected given the study's finding that "Average wealth amounted to $144,000 per person in the USA in year 2000, and $181,000 in Japan." In any case, the percentage of Americans who are in the top 10% is in-line with western Europeans.]

Let me be clear about my opinion, in case it isn't obvious from my writing: Being in the top 1% or top 10% of the world's wealthiest people is not something to be ashamed of. The fact that western democracies in general have higher levels of wealth than third-world dictatorships is something that should be celebrated. It means we are doing something right.

It is not the rich who are "filthy". It is the governments of those countries who are at the bottom of this survey's results...places like the Congo and Ethiopia...who embezzle not only their country's economic product, however meager, but also a huge percentage of aid given by the UN and the West. There are many reasons why a country might be poor, but in my view the single biggest reason left in the 21st century is bad government, and the refusal of the West to realize that we simply prolong the poverty and suffering of the world's poorest by continuing to give aid the way we primarily do, i.e. by government (or NGO) to government transfer.

The study notes that net assets of $61,000 get one into the richest 10% of the world's adults. While the relationship between disposable income and net worth varies with government policies such as taxation and welfare benefits, a net worth of $61,000 seems to correlate roughly to disposable income of $12,000. Assuming that a "household" includes two adults, the most recent US Census Department statistics show that roughly 82% of American households are likely to be in the richest 10% of the world by wealth. (Given that many households have fewer than 2 adults, the real number is likely to be higher.) I repeat, the fact that even poor Americans are rich by world standards is a badge of honor we should wear proudly.

The BBC news story on the study properly notes that "the report is not about policy recommendations" although one of the authors does stress the "importance of enhancing banking systems".

That is the real import of this study: What the West is doing, in terms of property rights, government, and stable private and public institutions, is making us wealthy. Instead of feeling guilty about it as the mainstream media would like us to, what we need to take away from this report is that by enabling corrupt governments though direct-to-government aid we are keeping poor people poor. To the extent that one considers income or wealth inequality a problem (which I certainly don't in America but do in third world kleptocracies) the answer is not to just send them more of our money. They are not poor because we are rich.

Posted by Ross Kaminsky at 03:30 PM | Email Author | Permalink

In the past seven weeks, the dollar has fallen 6.6% against the Euro (down 12.7% this year) and 3.5% against the Japanese yen (down 2.1% for the year). The Chinese yuan has reached a new high (5.7% higher than in July 2005) and the British pound is at a 14-year high against the dollar.

For many, this decline in the dollar is long overdue. For at least the past 20 years, conventional wisdom has argued that a large US trade deficit would force the dollar to decline. In the past three years, fears of a slowdown in US growth have caused many analysts to become permanent dollars bears.

But focusing on the trade deficit, the amount of Treasury bonds held by foreign investors, the budget deficit, or the savings rate, is a mistake. Like any commodity, the value of the dollar is a function of supply and demand. And because the Federal Reserve has sole control over the supply of dollars, any analysis that does not discuss the Fed would be wrong.

When the Fed is easy; look for a weak dollar. When the Fed is tight; the dollar will be strong. Of course, other central banks could also be tight or easy, and it is the relative policy stances of the central banks that matter. But, in the end, if the Fed wants to stabilize the dollar it can do so easily.

The Euro first began trading in January 1999. Its initial exchange rate against the dollar was $1.18/€. From its inception it tanked, falling to a low of $0.83/€ in October 2000. After bouncing around for the next nine months, it traded again below 85 cents in July 2001, but then immediately started to move higher - peaking at $1.36/€ in December 2004. The dollar strengthened in the first nine months of 2005, but has been very weak again lately.

Interestingly, Fed policy was very tight in 1999 and 2000 - eventually causing fears of deflation. The dollar soared. The Fed reacted to deflation by making monetary policy excessively loose and the dollar fell. Now, with the Fed on pause and policy not yet tight enough to drain the excess liquidity added the last several years, it should not be a surprise that the dollar has weakened again. Add to this the fact that fiscal policy appears to be shifting as a result of the recent change in Congressional leadership. Tax hikes and protectionism, regulation and growth of government, when combined with easy money are a perfect recipe for inflation and dollar weakness. Until these policy stances of loose money and activist government change, a shrinking dollar is highly likely.

Posted by Brian Wesbury at 01:30 PM | Email Author | Permalink

One of the centerpieces of Illinois Governor Rod Blagojevich's reelection campaign this year was a promise to raise the state's minimum wage. Last week the Democratic-led Illinois Senate delivered for the Governor, voting 40-17 to boost the state's minimum wage by a dollar an hour to $7.50. The hike goes into effect next July and will be followed by annual increases of twenty-five cents, eventually reaching $8.25 per hour in 2010.

The move catapults Illinois into one of highest minimum wage paying states in the country - and that has many people concerned about its potential drag on the state's economy.

According to a study by the AFL-CIO, Washington tops the nation with a state-mandated minimum wage of $7.63 per hour. Oregon is currently at $7.50 per hour, and Massachusetts will go to $7.50 per hour at the beginning of the year.

But in the Midwest, both Iowa and Indiana pay the federal minimum wage of $5.15 per hour, and Wisconsin is at a slightly higher rate of $5.70

Governor Blagojevich heralded the rate hike, but he's now left hoping Democrats in Congress can deliver on their own pledge to boost the federal minimum wage early next year. Otherwise, Illinois is going to be left at a distinct competitive disadvantage to its neighbors.

Posted by Tom Bevan at 08:30 AM | Email Author | Permalink

Paul Krugman is pessimistic about the economy.

Citing our friend Nouriel Roubini--NYU economics professor and head of his own forecasting firm--who has been predicting a housing led recession, Mr. Krugman points to the bond market and the fact that interest rates on long term bonds have fallen below rates on short term paper--in other words, an inverted yield curve.

Believe it or not, I actually agree with Mr. Krugman--insofar as the inverted Treasury curve suggests the Federal Reserve is too tight. Presently, the central bank's benchmark rate is 5.25 percent. Bernanke & Co. should lower their target rate to around 4.75 percent or even 4.5 percent. The curve is predicting continued economic softness, as is the current decline in the exchange rate of the U.S. dollar.

However, I disagree with Krugman on the record-breaking stock market. He believes stocks are "a notoriously bad indicator of the economy's direction" and cites Nobelist Paul Samuelson, who once quipped that the stock market had predicted 9 of the last 5 recessions.

But, as we discussed on last night's Kudlow and Company, the strong, across the board, 5-month rally in stocks cannot possibly be predicting a recession. While the stock market can sometimes emit false positives on recessions, rarely does it give off false negatives. In fact, I think it is predicting a Goldilocks soft landing for the economy.

A glaring omission from Krugman's analysis is the staggering rise in corporate profits. These are the tax return profits recorded for the IRS--rest assured that no CFO overestimates them. Corporations' pre-tax profits are up a remarkable 31 percent through the third quarter--25 percent after tax. These are serious numbers and are the mother's milk of business and the economy.

A question for Mr. Krugman: when in the history of humankind have we had a recession when business profits are rising by 30 percent?

Profitable U.S. businesses clearly have the resources to grow their operations and continue hiring new workers. This, in turn, is the biggest factor sustaining the historically low 4.4 percent unemployment rate, as well as the strong gains in employment and consumer incomes.

Over the past three months corporate payrolls have increase by an average of 157,000. The number of individuals employed as measured by the household survey has grown by an average of 319,000 during the period. It's no surprise that these jobs gains have significantly increased personal incomes. It has pushed real consumer spending roughly 3 percent at an annual rate above the 3rd quarter average. This also suggests a decent 4th quarter GDP growth rate may be in store.

Meanwhile, inflation readings continue to ease as the overall consumer price index has dropped to 1.3 percent over the past year, following tighter Fed money and the plunge in energy prices. This gives consumers even more purchasing power in the malls and on the Internet for the holiday shopping season. What's more, the big rally in homebuilders stocks suggests that the economic drag from housing is starting to peter out.

Markets are better forecasters than economic pundits or economic models.

Helped by lower energy prices, spectacular profits, and rock bottom tax rates on capital, the message from rising stocks is a soft landing growth scenario for next year's economy. The message from lower bond rates is lower inflation and an easier Fed next year.

So, I'm still betting on Goldilocks.

Posted by Lawrence Kudlow at 03:29 PM | Email Author | Permalink

Ben Stein's latest tax the rich article in yesterday's New York Times is so tragic because Ben is such a good guy, such a smart guy, that it pains me to say he has the story totally wrong.

Warren Buffett's secretary may have a higher tax rate than Mr. Buffett himself, but that's because Buffett made all his money from the 15 percent marginal tax rate on dividends and capital gains. Very few Americans live and work like this.

And anyway, jacking up taxes on capital investment is a completely dumb idea. What the American middle class needs is more investment to create new companies, new jobs and new technologies--all of which raise our standard of living.

Alan Reynolds, who has a new book out called "Income and Wealth," reminds me of a key reason why the top 1 percent saw their income share double to 16 percent from 8 percent. (By the way, the top 1 percent's tax share burden over the past 20 some odd years has gone from about 17 percent to 35 percent.) That is, that until recently, S-corps and LLC small businesses exploded to capture a personal tax rate that was lower than the corporate rate.

S-corp type income was only 7.8 percent in 1982, but was up to 28.4 percent in 2004, according to IRS reports. So it's just a tax shift, that's all it really is--a tax shift that is mistaken for outsized income gains.

What's more, transfer payments like the earned income tax credit, FSA and other welfare payments, as well as social security income, are not counted as low income resources.

Additionally, at lower income tax rates over the past twenty some odd years, there's been a lot less income tax evasion and a lot more income declaration--all of which shows how sensitive folks are to lower marginal tax rates.

Ben Stein says we can't cut spending. But in fact, as a share of GDP, Ronald Reagan cut spending from about 23 percent down to 20 percent; Clinton and the Gingrich Congress lowered spending to 18 percent.

Only recently, under the Bush Republicans, has spending jumped back to slightly over 20 percent. So it can be done. This is why I recommend a spending cap-spending limitation approach for Republicans. (And by the way, while many believe that CEO pay is just a continuous vertical line upward, the reality is CEO pay actually fell three straight years in the early 2000s.)

In the end, class warfare and higher tax rates will make the U.S. more like France. I don't want to be like France. Neither does Ben Stein--if he would think things through.

Posted by Lawrence Kudlow at 06:03 PM | Email Author | Permalink

Ideas matter.

So it is with great sadness to report and mourn the passing of Milton Friedman, whose lifelong writings on the paramount significance of freedom, free-market capitalism, and liberty helped overturn the evil tide of communism and socialism in the 20th century.

His great books Capitalism and Freedom in 1962, which was morphed into Free to Choose in 1980, and subsequently serialized on public television, reached literally tens of millions of people and influenced events in the U.S. and across the world.

He explained to us the failures and flaws in government interference in the economy through overspending, over-regulation and over-taxation.

He extolled the virtues of free trade.

He explained that the root cause of inflation is excess money creation.

Rather than Keynesian state planning, Milton's mantra of free markets, free prices, consumer choice and economic liberty is responsible for the global prosperity we enjoy today.

In fact, we take it for granted nowadays, but Friedman's was a long, uphill battle, fought over decades to persuade politicians and business people that government is the problem, not the solution.

He was a senior advisor to President Ronald Reagan who put these ideas into play during his transformative presidency.

When you look around the world, at newly capitalist economies sprouting up in Russia, Eastern Europe, China and India, you can't help but see the hand of Friedman.

When you review twenty-five years of virtually uninterrupted prosperity and near zero inflation in the U.S, you can't help but see the hand of Friedman.

Milton Friedman is one of those few people about whom it can be said that he truly left the world a better place.

May he rest in peace.

Posted by Lawrence Kudlow at 02:18 PM | Email Author | Permalink

The legendary economist has died. He was 94.

Posted by Tom Bevan at 01:41 PM | Email Author | Permalink

Most supply-siders and conservative pundits believe that if the Dems manage to take the House and Senate, President Bush's investor tax cuts will be safe because they have been extended to 2010.

Folks also think President Bush will veto any tax hike legislation that a new Democratic Congress might pass. Yes, yes, I believe Bush would definitely veto a direct tax hike bill. But the political story will be much more complicated than this.

Because if a Democratic Congress passes new "pay-as-you-go" rules, then the tax cuts will be severely jeopardized.

A revenue-oriented Pay-Go would show the static revenue loss each year that is scored by the Congressional Budget Office. This means that Harry Reid, Nancy Pelosi, Charlie Rangel, John Spratt and other Dems would be able to craft a so-called big bang deficit reduction package that would (falsely) cobble together spending cuts with tax revenue hikes.

President Bush might eventually be confronted with a Hobbesian choice of vetoing a so-called $500 billion dollar deficit reduction package that would overturn and rollback cap gains, dividends and the top income tax rate.

Inside the DNA of the Democratic party remains an obsessive desire to raise the income tax rate back to President Clinton's 39.6 percent. There exists a class warfare mentality that seeks to tax and penalize the rich. It is an obsessive, biological instinct to soak American success stories as some kind of Soviet style income leveling exercise that is supposed to make the non-rich feel better.

This is all nonsense--typical liberal left-wing pabulum.

The key point here is that Bush's tax cuts have done an amazing job in reigniting the U.S. economy. The 2003 tax cuts rallied the stock market, generated 6 ½ million new jobs, and have paid for themselves with soaring revenues that have, in turn, plunged the deficit. But this is all in jeopardy because of the potential of new pay-go rules.

I've checked with OMB budget officials on this. They confirm my green eyeshade memory from the days when I was President Reagan's associate budget director. Unfortunately, bad habits and bad thoughts have long shelf lives.

So, let me warn my fellow conservative friends and the investor class: a Democratic sweep come November will put Bush's hugely successful tax cuts front and center on the chopping block.

It's a sobering thought.

Posted by Lawrence Kudlow at 03:54 PM | Email Author | Permalink