March 08, 2007

Stock Volatility: It's Not the Economy

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.

February 26, 2007

Germany: A One-Year Wonder?

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.

February 22, 2007

Personal Saving Rate is a Misleading Indicator

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.

February 12, 2007

Bernanke Goes to the Hill

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.

February 08, 2007

Bad News for Romney

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.

No Need for Tax Hikes, Surplus on Tap for 2009

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.

January 29, 2007

Productivity, Goldilocks, and Inflation

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.

January 19, 2007

Did Someone Say Personal Savings Accounts?

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.

January 16, 2007

Don't Worry About the Inverted Yield Curve

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.

January 08, 2007

The Bronco Nation

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.

January 05, 2007

Job Growth Continues

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

January 04, 2007

A Quarter Century of Growth and the Risks Ahead

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.

January 03, 2007

Goldie Lives!

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.

December 11, 2006

Weakness in Housing and Autos Not Bad News

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.

December 07, 2006

They Are Not Poor Because We Are Rich

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.

December 04, 2006

The Shrinking Dollar

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.

Illinois Boosts Minimum Wage

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.

December 01, 2006

Krugman's Recession

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.

November 27, 2006

Taxes and Ben Stein

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.

November 16, 2006

The Hand of Friedman

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.

Milton Friedman, R.I.P.

The legendary economist has died. He was 94.

October 17, 2006

Class Warfare, Pay-Go, and the Democratic DNA

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.

September 28, 2006

China Tariff Takes a Hit

Today around 2pm, news broke that Sens. "Smoot" Schumer (D-NY) and "Hawley" Graham (R-SC) gave up for now on their China bashing tariff of 27.5 percent. This is a very good thing indeed.

Placing a huge tariff barrier between American and Chinese trade would have the same effect as imposing a large tax on the consumers, businesses and investors of both countries. It would completely disrupt economic growth worldwide.

Treasury Secretary Henry Paulson deserves credit for getting this delay and preventing a vote in the Senate that surely would have passed with very bad economic symbolism.

Fortunately, there is no similar tariff bill in the House. Chuck Schumer and Lindsey Graham apparently will now work through the Senate Finance Committee where Chairman Chuck Grassley (R-IA) is generally opposed.

China is far from our best friend in world affairs, but the widening economic links between our two countries is a definite plus for prosperity as well as diplomacy.

September 20, 2006

Deflationary Pressures Out There?

I'm sure the folks at the Fed are watching the commodity selloff of gold, silver, and various energy areas. And I'm equally certain they are watching the drubbing of metals and mining stocks, where Freeport-McMoRan was off yesterday around 5 percent and Phelps Dodge, U.S. Steel, and Alleghany Technology were down about 3 percent. The CBOE gold index was off 4.5 percent in yesterday's trading and 26 percent since May 10.

Money is tight. That's the message of the inverted yield curve where the 5.25 percent fed funds rate is way above most other maturities that are around 4.70 percent. The monetary base hasn't grown all year; it's been flat-lined by Fed actions to withdraw cash and raise their target rate.

The core PPI has dropped two straight months. Housing and autos are deflating. Yahoo is complaining about a big slowdown in ad revenues.

Working through the TIPS bond market model, the real fed funds rate is 2.85 percent, about 50 basis points above the real TIPS bond rate of 2.35 percent, which represents the economy's so-called natural rate.

The dollar bottomed two years ago and a combination of tight money plus reduced terror risk premiums are hauling in gold and oil prices.

As somebody who thought a couple of months ago that a neutral fed funds rate would be 5.5 percent, I am now coming to believe that a neutral rate would be 25 or 50 basis points lower.

Believe it or not, there are deflationary pressures building up out there.

September 14, 2006

Bad Ideas in Chicago

In the worst idea out of Chicago since, well, the band Chicago, unions in the Windy City are utterly determined to force big businesses to pack up and move to the suburbs.

They've been trying to punish Wal-Mart with a law passed by the City Council, But Mayor Daley has vetoed, and he made the veto stick yesterday. Still the unions won't back down. The Chicago Tribune weighs in with an editorial:

Unfortunately, supporters of the big-box law won't stand down. "... We may have lost this battle with the mayor. It doesn't mean the war is over," warned Dennis Gannon, president of the Chicago Federation of Unemployment.

Sorry, we meant the Chicago Federation of Labor.

The losers have come up with even worse ideas. There's talk of forcing a higher minimum wage on all companies that have at least 1,000 employees.

Yes, let's single out the most successful companies and push them to the suburbs.

There's talk of a citywide minimum wage that would be higher than the state and federal minimums.

Yes, let's give all companies that pay minimum wage a reason to flee the city.

Punishing productivity is the only thing the unions know how to do. Kudos to Wal-Mart for once again refusing to play ball with these thugs.

(HT: The New Editor)

About That Wal-Mart Article ...

The New York Times offers a whopper of a correction today:

Editors' Note

An article in Business Day on Friday reported that the Walton Family Foundation had made contributions to four conservative research groups whose analysts wrote articles favorable to Wal-Mart Stores for newspapers and journals around the country. The Times article said that the groups and their employees had consistently failed to disclose the donations, and it said in the first paragraph that the Manhattan Institute for Policy Research was one of them. But a Manhattan Institute author had told The Times that he had indeed disclosed contributions from the Walton Foundation in an article he wrote, a fact that should have been included in the Times article.

The article also reported that Tim Kane of the Heritage Foundation and Karl Zinsmeister, formerly of the American Enterprise Institute, were among those who wrote articles favorable to Wal-Mart after their foundations received a donation.

Both those groups were called for comment for the Times article. Mr. Kane, who was not called, subsequently said that he did not know about the Walton Family Foundation contribution and that he had criticized Wal-Mart's call for a higher federal minimum wage in an article he wrote. The Times also did not ask Mr. Zinsmeister to comment, but he declined to do so when reached after the Times article was published. Both Mr. Kane and Mr. Zinsmeister should have been asked to comment before publication.

Other than that, Mr. Editor, how was the play?

September 12, 2006

Capitalism Soldiers On - Larry Kudlow

Osama bin Laden threatened to bankrupt the United States. And, as recently as two days ago, al Qaeda's deputy leader al-Zawahiri said he was going to force our economic collapse.

Well, reality presents a far different picture. The U.S. and the world economies have prospered mightily since September 11, 2001.

The bulk of this credit goes to the ingenuity, entrepreneurship and stick-to-itiveness of Americans who go to work everyday. These hardworking men and women are an optimistic lot. They possess a great deal of faith in our nation, in our future, and in God.

Federal policies to cut interest rates and tax rates set the backdrop for this economic recovery and growth. Since that fateful day five years ago, non-farm payrolls have increased 4 million. 7.7 million more people went to work according to the household survey, which registered a declining unemployment rate.

Real GDP, total business investments, and household consumption all increased around 15 percent.

Inflation has run slightly above 2 percent. Household net worth has grown by 32 percent. American trade with the rest of the world increased 61 percent.

While fundamentalist Islamic radicals vehemently hate capitalism and freedom, and are doing everything they can to destroy our markets and economy, both have prospered worldwide despite these murderous hatemongers' wicked goals.

Robert Samuelson of Newsweek correctly points out that terrorism has been unable to slow the world economy. On the contrary, global trade has risen over 30 percent since 2001. Similarly, the world economy has expanded by more than 20 percent, with developing countries tallying a 30 percent gain.

Mr. Samuelson rightfully observes: "Terrorism so far has been an economic blank."

Interestingly, world stock markets have boomed during this 5-year terror period. The broadest U.S. average--the DJ Wilshire 5000--is up almost 30 percent. Even more fascinating, emerging markets around the world have gained over 200 percent. Even the stock index of the Arab gulf states has soared about 250 percent

Of course, the greatest story since 9/11 is that there have been no more 9/11s. Smart American security policies and the hard work of dedicated counterterrorism agents are successfully responding to this evil's potent challenge.

It is precisely this security that has enabled American workers and investors to prosper mightily and harness the economic and political freedoms the totalitarians hate so much.

The fact is, while terrorists have increased their attacks worldwide, they have been unable to stop the forward march of free market capitalism and globalization. These two powerful, resilient forces have produced extraordinary new wealth and increasing living standards worldwide.

This remarkable economic and stock market advance of the past five years clearly points to the fact that radical Islam and its murdering militants are completely isolated and doomed to failure.

Freedom, capitalism and prosperity roll on.

September 06, 2006

Changing Times Are Challenging Times - Brian Wesbury

It may sound trite, but technological change defines our world. And the changes are so rapid and dramatic that even the most astute observers cannot possibly grasp all the implications. Nonetheless, we see the benefits almost every day.

Last week, for example, we got a phone call from Russ Roberts, a professor at one of the best Economics schools in the country, George Mason University. Russ is also the features editor at the Library of Economics and Liberty and he wanted us to know that he had just posted the first of a two part interview with Milton Friedman. In a great service to the world, Russ is interviewing leading economists and thinkers (many of them Nobel laureates) and making those taped interviews available at

Because Russ is such a good economist, and these interviews are not constrained by the demands of television or print media, they are very valuable. They cover serious topics in depth and once again reveal the powerful nature of the Internet.

In the interview, Friedman said he was optimistic about the future, but he also fretted that the low inflation of the past 20 or 25 years could make people "bigger suckers." He feared that without specific rules in place to restrain the central bank, the government would try to use inflation as a form of taxation. He said, "sooner or later, government's are going to want to spend money without taxing it and the only way to do that is to print money--to create inflation."

"When I see in the Federal Reserve reports that the inflation anticipation for 10, 20 years is on the order of 2 percent a year," Friedman added, "I find it very hard to believe it. Sooner or later, the government's going to get out of hand."

These fears seem justified. The YOY change in the "core" PCE deflator has been at or above 2% for 28 consecutive months. In the past five years, the dollar has lost 56.7% of its value versus gold and 29.7% of its value versus the Euro. This is a clear sign that the Fed has printed too much money. Yet, concerns about inflation seem almost non-existent. Have we been lulled to sleep?

In another EconTalk interview, Harvard professor Robert Barro points out that "strong growth" in China and India caused a "dramatic reduction in world poverty over the last 25 years or so, and also some movement away from income inequality." The reason for this unprecedented improvement in living standards is twofold: the spread of technology and the adoption of capitalism and free markets.

It is true that technology is causing consternation and fear as "creative destruction" pushes the US and the world into a dramatic transformation, the likes of which we have not seen since the Industrial Revolution. But to suggest that we move away from free markets and utilize government power to slowdown the impact of technology and globalization, is to ignore the lessons of history.

We should not fear the economic revival in China and India. The world economy is not a zero sum game. The people exiting poverty are becoming entrepreneurs, inventors and customers. The forces of technology lift living standards as long as government stays out of the way. The right answer to closing the income gap, and raising living standards, is more freedom, not less.

Technology means opportunity. For example, some analysts bemoaned the loss of 13,500 retail trade jobs in August and even more so the 96,000 jobs lost in the past year. But this is not necessarily a sign of problems in the retail sector, which is also being affected by technology. Online spending is soaring, and product research and comparison is much easier on the Internet. As a result, we do not need as many employees working in retail. Between 2000 and 2006, inflation-adjusted (or real) retail sales per retail employee increased by 13.5% - from $19,200 to $21,800 per month. Even though total retail sales are at an all-time high there are roughly 70,000 fewer retail employees today than in 2000. This allows retail prices to remain low, which is an automatic boost to living standards.

Changing times are challenging times. But as Friedman and Barro remind us, the best government policies are still the tried and true policies of stable money, low taxes, and free markets.

(Brian Wesbury is the Chief Economist for First Trust Advisors in Chicago, IL)

August 21, 2006

Raise Taxes? - Larry Kudlow

Does the Congressional Budget Office truly believe that higher tax rates over the next ten years will expand economic growth and lower the budget deficit? This forecast of theirs simply defies economic common sense.

If that were the case, then why not raise tax rates across the board back to 70 percent, where Reagan found them, or even 91 percent, where JFK inherited them?

If it pays less to work and invest, after tax, as implied by the CBO, does anyone really believe people would work harder?

Over then next ten years, the budget agency expects 2.8 percent annual growth, when in fact over the past 50 years, growth has averaged 3.5 percent. What's more, rapid growth over the past 25 years with lower tax rates has greatly boosted this 50-year average.

So the idea that higher tax rates might balance the budget, or that an extension of lower tax rates will generate a $1.7 trillion higher deficit, just makes no sense at all.

Mainstream economists today believe that tax incentives matter. All but the farthest left economists like Paul Krugman and his ilk believe that economic behavior is highly responsive to changing tax rates. The CBO is telling us otherwise and it just doesn't figure.

Of course, these long term economic and budget projections remind us of Friedrich Hayek's fatal conceit. That is, government planners can accurately predict the future. I don't think so. Consequently, with all due respect to the professionals at CBO, I just don't buy into their new numbers.

Perhaps they should focus more clearly on the here and now. What's happened in recent years following the Bush tax cuts is a stronger economy, much higher tax revenue collection, and continuous downward estimates of the budget gap.

This is the real story.

August 08, 2006

Bears on the Prowl - Larry Kudlow

Judging by recessionary worries in the press and blogosphere, the cult of the bear appears to be alive and well.

The bears are focusing on housing, consumers and the slightly inverted yield curve. It's a heavy demand-side forecast approach. Supply-siders like myself look at low tax-rates on capital, high productivity, record profits, and strong industrial production.

While the jobs trend is slowing, it remains quite healthy. And 100,000 to 120,000 average monthly job gains are consistent with roughly 6 percent growth in personal income. The main point is a very low cost of capital and very high investment returns to nurture investment.

The bears ought to consider the high level of commodity prices as a sign of U.S. and world economic strength. The yield curve is not deeply inverted, but only slightly. Back in 2000 the curve was hugely inverted for about a year and the Fed deflated the money supply in 2000 after rapidly inflating it in 1999.

World political risk and uncertainty is keeping commodity prices way above equilibrium. Inflation-adjusted GDP growth is slowing toward a 3 percent trend line, but this seems more a function of rising inflation, which is crowding out real growth.

Inflation is the biggest factor in the economic outlook. If it jumps to 4 or 5 percent in the next year, then real growth will surely slump and the balance of forces could conceivably slip into recession.

An interesting thought on inflation -- industrial and energy prices have, of course, surged. But in the technology sectors prices continue to deflate.

The Fed is moving into a more restrained monetary stance, as illustrated by the decline of commodity and economic-sensitive stocks since the May 10 FOMC meeting. But there's a big difference between a flat curve and a deeply-inverted curve.

Also worth noting is that corporate credit spreads are narrow, another sign of business health and profitability. Unit prices are running ahead of unit costs, another positive for profits.

The bears also overlook the strength in business. In the last cycle, the most accurate measures of corporate profits peaked in 1997 and deteriorated through 2002. I just don't see any of this right now.

I also don't see any imminent government policy blunders like a move to higher tax-rates, heavy regulation or protectionist tariff increases. If the Dems take over Congress come November, I think President Bush will morph into Grover Cleveland and veto Democratic tax hike proposals.

Over the next 12-18 months, prior Fed restraint will definitely slow down money GDP growth. But that same restraint should also contain inflation around the 2.5 percent zone. Hence the probability of a 3 percent real GDP trend is still reasonably high.

An abrupt oil spike to $90 or $100 would be a recessionary factor. And who can predict events in the Middle East? But back at home, the supply-side impetus within our resilient and durable free market capitalist economy is still underrated, or shall I say "misunderestimated" by the cult of the bear.

August 02, 2006

Bush, Bartlett and Free Trade

Rich Karlgaard takes on Bruce Bartlett.

July 26, 2006

Housing Slowdown

Mark Trumbull of The Christian Science Monitor gives a national view of the housing slowdown. The effect is even more pronounced here in the Chicago area.

July 20, 2006

Bernanke's Testimony - Larry Kudlow

Some quick thoughts on Ben Bernanke's testimony yesterday:

The best thing I saw was his reference to a very healthy and sound business sector with high productivity, strong profits, plenty of cash, and a strong backlog of new durable goods orders, which suggests big capex spending in the future.

The testimony itself was fairly bland. It's an economic forecast-driven Fed outlook, based on the Fed's own models, that apparently show a sizable decline for economic growth in the second-half of this year, along with a moderating core inflation rate. Implicit in the forecast is about a 2.5 percent second-half growth rate that I think is too low. So, if Bernanke is operating policy through the economic growth rate, there will be one or two more tightenings this year. On inflation he could be right.

Bernanke's testimony was definitely not a supply-side approach to economics. He did mention a TIP-based forward indicator of inflation, but there's really no clear liquidity model that relies on sensitive market price indicators like gold, commodities, and the dollar. I do like the TIP model reference, which looks to me about 25 basis points too wide. I definitely favor a 5.5 percent fed funds rate target.

I was disappointed that Bernanke made no mention of the dollar. Nor did he mention lower tax rates on private investment as a spur to economic growth. Because of low tax rates, I continue to believe the economy will surprise on the upside in the month's ahead. That is why I think the Fed will feel compelled to raise rates a bit more. That being said, an investment-led expansion is counter-inflationary, as supply drives demand and more goods are available to absorb the existing money stock. Low tax rates are similarly counter-inflationary.

But this is a data-driven approach to Fed policy. Looking through the rear-view mirror, I preferred Alan Greenspan's seat of the pants approach, which left room for more scrutiny of market-based indicators of both inflation and growth.

All of this leaves me still nonplussed about our new chairman, who is very much a state of the art economic scientist. I just don't think scientific models are nearly as accurate as market-based price watching.

July 19, 2006

War on Wal-Mart

A big setback for the anti-Wal-Mart campaign. A federal judge has ruled that Maryland can't dictate what percentage of Wal-Mart's payroll must be dedicated to health care.

In essence, the Maryland law hurts Wal-Mart by making it track employees in Maryland differently than it tracks employees in other states.

The war on Wal-Mart, however, is sure to continue.

July 10, 2006

Tax Cuts, Budget Deficits and the Economy - Brian Wesbury

This week, the White House will revise its fiscal year 2006 budget deficit estimate to roughly $300 billion, a significant reduction from its January forecast of $423 billion. This will continue the White House's pattern of very conservative estimates.

Our calculations suggest that the federal budget deficit this year will be approximately $260 billion. This is down from $318 billion in FY-05 and $413 billion in FY-04.

Strong gains in tax receipts have overwhelmed increased federal spending. Congressional Budget Office (CBO) data show that federal tax receipts during the nine months ending in June were 12.8% above the same period in FY-05. Withheld income taxes increased 9% in June from last year; non-withheld income tax payments surged by 20%, while corporate tax receipts grew by 17%.

If federal receipts continue to grow in a similar fashion during the final three months of this fiscal year, they will climb to an all-time high of $2.4 trillion dollars, $275 billion above last year, $400 billion more than in 2000, and equal to 18.5% of GDP.

Federal spending is on track to increase 9% this year, and will end the year at 20.7% of GDP, up sharply from the 18.4% share in 2000. If federal spending had remained at 18.4% of GDP this year, the US would have recorded a small surplus of $21 billion.

It has become popular to say that, "tax cuts do not pay for themselves." In fact, Henry Paulson, who will be sworn in today as the 74th US Treasury Secretary, was all but forced to say this in his confirmation hearing last month. The problem is that it is not clear whether this statement actually means anything.

In a static world, tax cuts do not pay for themselves. But the world is not static. As Secretary Paulson said at his Congressional hearing, tax changes affect people's behavior. As a result, tax changes alter the course of the economy. To assume otherwise is naive. Equally as important is the fact that different types of tax cuts impact the economy in different ways.

In 2001, most reductions in marginal income tax rates were phased-in over many years. But, if people know that tax rates will be lower in future years they will push as much economic activity as they can into those lower tax years. This resulted in anemic economic growth (and declining tax revenue) during 2001, 2002 and early 2003 even though the Fed was cutting interest rates.

The 2003 tax cut ended the phase-in, accelerated the tax cuts and reduced tax rates on qualified dividends and long-term capital gains. This caused an immediate acceleration in business investment and tax revenues surged. In fact, inflation-adjusted tax revenues have grown more than 10% annually over the past two years; a feat rarely accomplished in US economic history.

As a share of GDP, tax receipts are still well below the 1998-2000 average of 20.3%. But those were abnormal years. Since 1930, there have only been 19 years in which the tax share of GDP was at or above 18.5%, and in the past 20 years, tax receipts have averaged 18.3% of GDP. This means tax receipts in 2006 will be above historical norms.

Since the tax cut was passed in May 2003, US GDP has expanded by more than 20%, or roughly $2.2 trillion. To put this in perspective, we have added more to GDP in the past three years than an entire China (current estimate of $1.9 trillion in annual GDP). In the three years before the tax cut, GDP in the US grew just 10.4%.

Most importantly, tax revenue trends suggest that government statistics are underestimating economic growth. People and companies do not pay taxes on income or profits they do not earn. There is no sign of a slowdown in the budget data.

(Brian Wesbury is the Chief Economist for First Trust Advisors in Chicago, IL)

July 05, 2006

The Bush Boom - Larry Kudlow

Conventional demand-side economists keep talking about an economic slowdown. (See today's WSJ front-page story (reg req)).

These folks are stubborn if nothing else. They ignore the huge success of supply side tax cuts that lowered the marginal tax rate on capital to the lowest level in history.

Private business investment continues its surge. It remains an explosive engine of growth creating jobs, incomes and consumer spending.

The thought here is very simple: Low tax rates on capital benefit both businesses and consumers. In fact, a combination of record low taxes and record high profits is the key to understanding our current economic boom, which is the greatest story never told.

Just take a look at today's factory orders report for May. It shows that order backlogs are surging at a 13 percent rate. This is yet another indicator of the business boom.

Moreover, the ADP jobs report hints at a much stronger than expected jobs gain in Friday's report--368,000 new jobs in June, compared to street consensus of only 160,000. (This is the largest monthly increase in employment since the ADP index was created five years ago.)

Yet, the demand-siders continue their doom and gloom. They've predicted four or five growth pauses in the last three years, as the economy shrugged off their pessimism and roared ahead. They have been wrong over and over again. And all signs suggest they will continue to be wrong.

Low tax rates work. Just look at the economy.

June 30, 2006

The Canary Chirps Again on Inflation

Immediately following the release of the Fed's statement yesterday, which took a much more dovish stance against inflation than a few weeks ago, gold prices surged and the dollar plummeted. Like a canary in a coal mine, these market movements indicate that a "pause" by the Fed in its rate hiking campaign would be an inflationary mistake.

Before advanced technologies, coal miners used caged canaries as a signal for the build-up of dangerous gases. If the bird died or had problems breathing, the miners knew there was a problem.

For inflation, the canaries are commodity prices and the value of the dollar. The sensitivity of these markets to detect monetary policy ease or restrictiveness has become very clear in the past decades. If the Fed prints too much money, commodity prices rise and the dollar falls. When the Fed is too tight, the opposite happens.

The price of gold fell from roughly $400/oz. in 1996 to less that $260 in 1999. Other commodity prices also fell, while the dollar surged to its highest level in decades. Despite these early warnings from gold and the dollar, the Fed was still blindsided by a brush with deflation in the early 2000s. It did not pay attention to the canary; and this was a huge mistake.

Since 2001, with the Fed fighting deflation, gold and other commodity prices have been on the rise and the dollar has been falling. These are early signs of an overly accommodative monetary policy, and it should not be surprising to see "core" measures of inflation beginning to rise. Nonetheless, many on the Fed and a large contingent of private sector and academic economists downplay the signals sent by these markets.

One typical argument is that commodity prices play only a small role in the US economy, especially as services grow relative to manufacturing. But this argument misses the point. It is not the feed-through of rising commodity prices (even oil) that causes inflation. Rather, it is easy money that causes inflation, and the sensitivity of these markets to dollar liquidity means that they provide the earliest warning sign of a Fed mistake. Commodities and currencies are traded every moment of every trading day and their prices are finely calibrated with the supply of dollars in the system.

(Brian Wesbury is the Chief Economist for First Trust Advisors in Chicago, IL)

June 27, 2006

The Promiscuous Octopus on the Slate

Over at Slate, they're having a dialogue on the good/evil of Wal-Mart in the American economy. I've long been a defender of the promiscuous octopus -- just doing my part to stick it to the little guy on behalf of The Man.

Anyway, on the pro-Wal-Mart side is Jason Furman, who wrote a controversial paper on Wal-Mart as a progressive success story (PDF).

Here's a passage from his opening salvo, over at Slate:

Are you as surprised as I am by how quickly Wal-Mart's critics move past the issue of low prices? You will hear comments like, "Yes, Wal-Mart may have somewhat low prices, but let's talk about its impact on workers, the environment, trade with China, etc." But given just how important these low prices are to the hundreds of millions of Americans that shop there, I hope I can beg your indulgence to linger on them for a few moments.

A range of studies has found that Wal-Mart's prices are 8 percent to 39 percent below the prices of its competitors. The single most careful economic study, co-authored by the well-respected MIT economist Jerry Hausman, found that grocery sales by Wal-Mart and other big-box stores made consumers better off to the tune of 25 percent of food consumption. That doesn't mean much for those of us in the top fifth of the income distribution--we spend only about 3.5 percent of our income on food at home and, at least in my case, most of that shopping is done at high-priced supermarkets like Whole Foods. But that's a huge savings for households in the bottom quintile, which, on average, spend 26 percent of their income on food. In fact, it is equivalent to a 6.5 percent boost in household income--unless the family lives in New York City or one of the other places that have successfully kept Wal-Mart and its ilk away.

He's right, of course. A huge portion of the Wal-Mart debate happens among people who shop at Whole Foods. I've hardly ever been inside a Wal-Mart. I'm more of a Fresh Direct guy these days. But the people who get hurt when, say, the unions in New York City keep Wal-Mart out are the ones who would be saving a significant chunk of their budget if a supercenter could open in Queens or The Bronx and Staten Island.

June 22, 2006

Forget the Economy, It's All About the Politics Stupid! - Larry Kudlow

There's a big political hullabaloo brewing this election year over a minimum wage hike. What a surprise. This thing only seems to pop up during election years.

The economics of a minimum wage hike are terrible.

Think of fast-food restaurants and small eating establishments that hire young workers of all colors and races, especially during the summer. These students and others will be priced out of the labor market because of the higher minimum wage.

Did you know that only about 2 ½ percent of the total workforce (slightly less than 2 million people) qualify for the minimum wage according to the Department of Labor Statistics?

And did you also know that roughly four-fifths of all the minimum wage workers are un-poor? Two-thirds of the minimum wage workers actually come from families where at least one other family member has a job. (These stats courtesy of Harvard economics professor Greg Mankiw's website.)

Think students in high school or college.

But, unfortunately, the politics may prove too compelling this election year. So here's my thought:

Tie a minimum wage hike to a tax cut for large and small businesses. Or even a big estate tax cut.

Then, the costs of a minimum wage hike would be offset by lower tax costs. We would get another tax cut on capital that would obviously help spur the U.S. economy.

I guess my hope here is to turn a negative into a positive.

June 20, 2006

Corny Energy Policy

If you missed it, the Wall Street Journal had a terrific editorial over the weekend as to why ethanol is still a bad idea, even in the current "crisis":

U.S. taxpayers today pay twice for ethanol: once in crop subsidies to corn farmers and again in a 51-cent subsidy for every gallon of ethanol. Without such a subsidy, ethanol simply wouldn't be cost competitive with gasoline. Then last year, Congress went further and passed a new ethanol mandate, requiring drivers to use at least 7.5 billion gallons annually by 2012.

The immediate consequence of this new mandate was higher gasoline prices this spring, since the ethanol industry was ill-equipped to meet the new demand. Ethanol must also be carried by truck or rail, rather than through pipelines, and it requires special blending facilities. All this has both raised prices and created gas shortages around the country. But rather than blame their new mandate for the higher prices, the Members of Congress blamed, of course, Big Oil.

Ah, but what about the other alleged virtues of ethanol? One favorite is that every gallon of ethanol will supplant a gallon of gasoline imported from tyrannical Mideast oil regimes. Thus, a la Brazil, ethanol can help the U.S. achieve the miracle of "energy independence."

Sorry. The most widely cited research on this subject comes from Cornell's David Pimental and Berkeley's Ted Patzek. They've found that it takes more than a gallon of fossil fuel to make one gallon of ethanol--29% more. That's because it takes enormous amounts of fossil-fuel energy to grow corn (using fertilizer and irrigation), to transport the crops and then to turn that corn into ethanol. The Saudis ought to love the stuff.

Ethanol might have a place in a Giuliani-style "diversification" of U.S. energy policy. But it still have a long way to go as a technology.

June 16, 2006

The Resilient Economy - by Brian Wesbury

Imagine you were working on a 500-piece puzzle and had assembled 497 pieces, but found out that the last three pieces did not fit. In fact, you realized that they were from a completely different puzzle all together. What would you believe, that the three pieces were the right ones and the 497 were wrong, or vice-versa?

This is an important question for people looking at economic data these days. Those who think the economy is slowing focus on the 0.1% increase in retail sales during May. But, one or two-month slowdowns in economic data mean nothing. Retail sales are up 7.6% in the past year and 8.5% at an annual rate over the past six months. Excluding autos, retail sales increased 0.4% in May and are up 9.1% in the past year and 9.6% at an annual rate in the past six months.

Moreover, the future for retail sales does not look dour at all. Yes, non-farm payrolls increased by a less than expected 75,000 in May, but the household survey reported a 288,000 jump in employment. The Household Survey has been a much more accurate predictor of economic strength in this recovery than the Establishment Survey.

The unemployment rate has fallen to 4.6% and average hourly earnings have accelerated sharply in recent months, rising at a 4.2% annualized rate in the past six months. Wages and salaries have accelerated as well, rising at a 7.9% annual rate in the first four months of 2006. Tax revenues to the federal government are growing even faster (13% above last year during the first eight months of this fiscal year) and people do not pay taxes on income they do not earn.

While industrial production data showed a decline of 0.1% in May, output has climbed 5.2% at an annual rate in the past three months and 4.4% in the past year - both faster than overall GDP.

Early data for June signals a rebound. Initial unemployment claims have fallen to 295,000, while the Philadelphia Fed manufacturing survey was 13.1 in June - a level that is indicates real growth in the 3.5% to 4.0% range. New orders in the Philadelphia area rebounded strongly in June with 31.8% of area manufacturers reporting rising orders and only 14.1% reporting declining orders - another signal of stronger than anticipated growth ahead.

Along with data that reflects a solidly growing economy, inflation remains elevated. The Consumer Price Index expanded by 0.4% in May, while the "core" CPI jumped 0.3%. No matter how you slice and dice it, "core" inflation is clearly running well above the Fed's comfort zone.

The bottom line is that the economy is still in very good shape, while inflation is moving higher. It may be easy to pick out some data here, or some anecdotal evidence there, that paint a picture of slower growth. However, that evidence is in the distinct minority. When put together, a vast majority of the data reflects an economy that continues to roll along much as it has for the past three years.

(Brian Wesbury is the Chief Economist for First Trust Advisors in Chicago, IL)

June 13, 2006

Is the Economy Really Slowing Down? - by Brian Wesbury

Real GDP expanded at a 3.3% annual rate in the second quarter of 2005. This was followed by a 4.4% growth rate in the third quarter and then a post-Katrina swoon of 1.7% in the fourth quarter - which many took as a sign that the economy was slowing. Nonetheless, a post-Katrina rebound boosted real GDP to a barn-burner 5.3% rate in the first quarter of 2006. First Trust Economics' expects second quarter growth to slow to 2.8%.

Assuming that this forecast is correct, real GDP will have expanded at a 3.5% rate during the four quarters ending in June. Not bad for a year with nine rate hikes, $3 gasoline, $70 oil, $11 natural gas, the loss of our 35th largest city to a hurricane, a slowing housing market, stumbling consumer confidence, and general malaise in most national polls regarding the health of the economy and the performance of our President.

The question, however, is not what the economy has done, but what it will do. A majority of economists, including those at the Federal Reserve, believe that the economy will continue to weaken as this year unfolds. The story line goes as follows: The cumulative (and lagged) impact of rising interest rates and energy prices, combined with a slowdown in housing will undermine consumer purchasing power.

Certainly, it appears that this is exactly what happened in our current quarter. Real consumer spending is expected to slow to 2.0% annualized growth from 5.2% in the first quarter, while real residential investment is expected to decline by 3.0% after growing at an equivalent 3.0% annual rate in the first quarter.

However, the assumption that this trend will continue is a forecast, not a given. We do not believe that the economy will slow much, if at all, in the second half of 2006. Leading indicators of business confidence remain robust. Heavy duty (above 14,000 lbs.) truck sales were 10.5% above year-ago levels in the first quarter, while capital goods orders (excluding defense and aircraft) were up 9.2% year-over-year in April.

In addition, while consumer attitudes have swooned, the actual state of the consumer has improved. The unemployment rate fell to a cycle low of 4.6% in May and average hourly earnings have increased 4.2% at an annual rate in the past six months, their fastest six-month growth rate since 2000. Moreover, household wealth hit another record high in March, rising to $53.8 trillion. Contrary to conventional wisdom, US households are some of the best savers in the world. In an additional sign of economic strength, tax revenues are surging - up 14.6% last year and 11.2% so far in 2006.

The underlying drivers of the economy are still pointed upward. Productivity is strong, tax rates remain low and our models suggest that a "neutral" federal funds rate is roughly 6%. The Fed is definitely less loose than they have been in recent years, but monetary policy is not yet tight.

As long as these underlying forces remain pointed in their current direction the economy will continue to grow at a faster than average pace. The things we worry about have nothing to do with rate hikes, high energy prices or the housing market. The four things that can kill an economy are all policy related - tax hikes, trade protectionism, government over-spending or regulation, and bad monetary policy. Talk of a major budget summit being pushed by some in Congress and the White House, that could address entitlement spending, is especially dangerous if it leads to tax hikes. But any deal is still way off in the future. In the meantime, the economy is robust enough to grow strongly in the second half.

(Brian Wesbury is the Chief Economist for First Trust Advisors in Chicago, IL)

June 09, 2006

Hooray for the Death Tax! - by Larry Kudlow

Okay, so the estate tax cut went down in the Senate; class warriors rejoiced.

Congratulations to Democratic Senators, Evan Bayh, Mary Landrieu, Ron Wyden, and Mark Pryor, who all voted against death tax repeal, after voting in favor of it a few years ago. At last! They have finally have come to their senses!

Congratulations are also in order for Republican Frank Keating. After crusading for abolition of the death tax when he was governor of Oklahoma, he is now getting right-sized in firm opposition as K Street's newest insurance lobby hero.

I think all of this is great. America should attack rich people. We must abolish wealth. It's a tremendous drag on our economy. It's high time that we made the rich, poor.

In fact, for all the xenophobes that want to depart the illegal immigrants who are helping our economy, may I respectfully suggest that their generals (i.e. Lou Dobbs, Pat Buchanan, and Tom Tancredo and company) consider expanding their dragnet? Let's deport rich people too!

These rich people are bad for America.

We don't want their ingenuity, or their entrepreneurship, or their capital investment. They are not crucial to creating new high growth companies and jobs. We just don't want them. Actually, I think we should figure out ways in the name of egalitarian socialism, to tax their dollars even more times. It definitely is right that they're not taxed enough.

So, in addition to taxing rich incomes, once as salaries, a second time as corporate profits, a third time as dividends, a fourth time as capital gains, and a fifth time at death, there must be a way to tax them again.

Perhaps, if they donate huge contributions to charities there should be a tax?

Or if they build a new church or synagogue, tax 'em. Or if they create another college, tax em. Or if they finance private scholarships, or inner city kids' education at parochial schools, or Hebrew schools, tax 'em. Or if they just go about their business and consume goods and services, can't we have a special tax surcharge? Or if they buy a new home that employs ten, twenty, or fifty construction workers, I say slap a high rich person's tax. Or if they hire a driver, tax 'em. If they show up at a five-star restaurant, tax 'em.

In fact, lets criminalize the entire class of successful American entrepreneurs. Let's haul out the Joint Tax Committee and Congressional Budget Office's distributional tables, and target the upper-end income earners for special wealth taxes.

I like the idea from my crazy Wall Street Journal editorial friends, who talk about "dying for dollars." Maybe we can even impose jail sentences for rich people! No more interest income just like the radical fundamentalist Muslims!

Let's publish their names in newspaper and blog sites. Let's encourage the class warfare, "soak the rich" advocates to swarm over them when they appear on streets and towns, just like the animal rights people, who throw paint on women in mink coats.

We must strive to make America like France or Germany--income leveling; income redistribution. Remember how well this worked with the old Soviet Union?

Actually, I checked the international tax tables and found that the U.S. only has the third highest estate tax rate of the top 50 countries. We should be ashamed of ourselves. Only third? We tax estates at a 46 marginal rate, but Japan is the best at 70 percent, followed by South Korea at 50 percent. We are pikers. We must not let this happen. How can we let Japan be ahead of us on taxing rich people?

The fact that 24 countries have a zero estate tax rate, including China, should not concern us. They don't know what they're doing. And, surely, we don't want to be competitive in the world economy. We want to hang a sign out: "Capitalists are unwelcome to the United States." Let's make the whole country like New York.

This idea of keeping more of what you earn and own is just plain stupid. In fact, this whole capitalistic notion, which is spreading worldwide, is just one of these temporary, bizarre, worldwide trends that will undoubtedly be soon reversed, as people come to their senses.

Czech Republic, Estonia, India, Indonesia, Malaysia, Mexico, they're obviously all nuts with their zero tax rates on estates. Did I say Mexico? That's perfect. As I said earlier, we will deport all our rich people to Mexico. At a zero estate tax rate, they're likely to produce and invest so much more, that they will completely revive the stagnant Mexican economy.

Instead of creating thousands of new businesses and millions of new jobs in America, along with funding schools, colleges, symphonies, cultural centers, hospitals, medical research and so forth, they can do it for Mexico. That of course will solve our immigration problem. What a great idea! Why didn't I think of this earlier?

Meanwhile, Senator Kyl's fallback position of a fifteen percent rate, after exempting the first five million dollars of an estate, is an equally demoralizing idea. That would move us much too close to Canada, Australia and Argentina, which also have a zero rate. That would also promote the foolish incentive idea that there is a link between reward and work, or reward and risk. This crazy, far-out, ultra right wing idea that it must pay after-tax to work and invest is insane.

After all, we know that the best way to generate more saving and investment in this country is to tax it more. That'll do the trick. Contrary to the brilliant Arthur Laffer, the tax the rich crowd must be exactly right with their newfangled, modernistic, 21st century idea that if you tax something more, we will get more of it. Huh?

This may all sound wrong, but these soak the rich guys are deep thinkers. They have their fingers on the pulse of the hundred million strong Investor Class. They know that the worldwide spread of free market economics, which was launched by Reagan and Thatcher, twenty-five years ago, and which has raised global prosperity to record heights, caused the phenomenal growth of middle classes in places like India, China, and Russia, along with record amelioration of poverty, is absolutely nuts.

After all, capital is the enemy of labor! Forget about the obvious fact that you can't create a new job without a business. And you can't fund a new business without capital. Forget all that. It's obviously wrong.

Once again, capital is the enemy. Rich people are evil. We have to put an end to all this capitalist, supply-side nonsense.

By the way, when is Karl Marx' birthday? I have to stop writing now, so I can go look it up. I can't wait to celebrate the master's birthday...

June 06, 2006

Bernanke's Back on Message - by Larry Kudlow

Ben Bernanke got back on message with his strongly worded statement yesterday that, "maintaining low and stable inflation is essential for achieving both parts of the dual mandate assigned to the Federal Reserve by the Congress. In particular, the evidence of recent decades...supports the conclusion that an environment of price stability promotes maximum sustainable growth...."

He specifically mentioned the mild upcreep of recent inflation reports over the past 3-6 months as being, "unwelcome developments."

Stock markets have been jolted downward, and this correction will run its course. But more rate hikes from the central bank as they drain excess cash from the economy will in the medium and longer run, be very positive for the economy and stock market.

In effect, Bernanke is reaffirming his numerical inflation target of 1 percent to 2 percent. Basically this is a price rule that will conquer long run inflation expectations. It's a good thing.

Meanwhile, the economy is much stronger than Wall Street and media demand-siders are telling us. Profitability is high; productivity is strong; business is healthy; jobs are rising; and tax rates are low. Commodity stocks are plunging as the dollar is recovering.

This is as it should be, as markets discount a slower pace of dollar creation. When dollars are scarce, the greenback rises. Before long, this will spread to rising financial assets, especially stocks. Commodity assets are sold. This forms the basis of the market correction.

But the health of business will carry the day after the correction is completed.

It is good to see Mr. Bernanke regain his footing. His monetary manhood is back. He is putting away his Neville Chamberlain umbrella.

Inflation appeasement is over.

May 30, 2006

Paulson is a Good Choice - by Larry Kudlow

People tell me it's not easy being a pro-Bush Republican in the executive suite at Goldman Sachs.

So give Treasury nominee Hank Paulson some credit for holding the line. And give Josh Bolten credit for indefatigably recruiting Paulson, his former Goldman partner, even in the face of apparent turndowns.

Mr. Paulson is a well-regarded, top-rated Wall Street exec at the powerful Goldman Sachs who will bring considerable credibility to the top Treasury job. He is a confirmed free trader who strongly supports deepening economic relations with China.

Mr. Paulson also supported Bush's investor tax cuts, and has worried out loud about the impact of SarBox on American competitiveness.

Goldman insiders tell me that he is something of a "greenie," having been active in the Nature Conservancy, but they say he's no Al Gore, and prefers technology advances by private enterprise to solve energy and any global warming issues.

We don't know his specific view on the value of the U.S. dollar, but hopefully he'll work with Ben Bernanke to strengthen the greenback and hold down inflation expectations.

Whether there's a pro- growth tax reform agenda, or a new look at Social Security and other entitlements remains to be seen.

My guess is Mr. Paulson will command much more policy influence at the Treasury than his predecessors had. All in, Paulson looks like a good choice, strong, capitalist choice.

Nominal GDP, the Fed and Nirvana - by Brian Wesbury

Ask anyone what the Federal Reserve controls and you will most likely get an answer having to do with interest rates. And while most people should be forgiven for believing this, they would be dead wrong. The Fed has direct control over only one thing - money.

By using open market operations, the Fed can add or subtract reserves from the US banking system at will. When it adds reserves the federal funds rate falls. When it subtracts reserves, money becomes less plentiful, and the federal funds rate rises.

While 99% of the stories carried in the business press focus on these changes in interest rates when talking about the Fed, it is not the rates that matter, but the money. The growth rate of the money supply determines the growth rate of nominal GDP, or total spending.

The idea is simple really and is described by "The Quantity Theory of Money." This equation (MV=PQ) is attributed to Irving Fisher. The equation says Money x Velocity = Price x Quantity.

More succinctly, the change in the money supply and the change in how fast that money is spent will equal the change in total spending. If the Fed increases the money supply by 6% (and velocity does not change), then nominal GDP (real growth plus inflation) will grow by 6%. The faster the money supply grows, the faster total spending grows - assuming constant velocity.

In the 1930s, the Fed allowed the money supply to contract. This incredibly damaging mistake caused nominal GDP to decline. The US experienced deflation and falling real output at the same time. In the 1970s, the Fed created too much money. Between 1978 and 1981, nominal GDP grew at an annual average rate of 10.9% - real GDP averaged 1.8%, while inflation averaged 8.9%.

Understanding this is the key to understanding Fed policy. It shows exactly how accommodative Fed policy has been in the past few years. During the deflationary years of 2001 and 2002, nominal GDP grew just 3.3%. But in the past three years, nominal GDP has grown at an annual average of 6.8% - the fastest three-year growth rate since 1990.

Moreover, our models indicate that to be "neutral," the federal funds rate should be within 1% or less of the growth rate of nominal GDP. A "neutral federal fund rate" is when money supply and money demand are in balance - when nominal growth is stable.

In other words, if the Fed had hiked rates faster in 2004 and 2005, nominal GDP would have stabilized at a slower rate and the Fed would already be at neutral. Instead, the measured pace of Fed rate hikes left the Fed "behind the curve." Our models suggest that today's 5% rate is roughly 100 basis points below a true neutral rate. The longer it takes the Fed to hike rates to 6%, the faster nominal GDP will grow and the higher the neutral rate will become.

While conventional wisdom suggests that the Fed will pause soon, we suspect that this is just wishful thinking by many who felt the Fed would stop hiking months ago. While 16 consecutive rate hikes have created a great deal of consternation for those who view the Fed only in terms of interest rates, monetary policy is not yet tight. The more accurate description is that policy is just "less loose." If the Fed can lift rates to 6% by autumn, our models would judge this as monetary policy nirvana.

May 24, 2006

Larry Kudlow: Bernanke is Off Message

Fed Chairman Ben Bernanke is totally off message.

His admission to Senator Jim Bunning of a "lapse of judgment" in the Bartiromo kerfuffle is pure process--not content. His "data-driven" approach to policy is backward looking driving through the rear view mirror.

Bernanke should go back to his confirmation hearing statement, when he stated that price stability is the cornerstone of economic growth. This should be his main message. He should resurrect his numerical inflation target. And he should publicly say that enhanced dollar value is vital to price stability.

Also, he should reemphasize forward-looking market price indicators, which includes a widening breakeven inflation spread in the TIPs bond market, abnormally high gold and commodities and a dollar exchange rate that is too low. A few more quarter-point rate hikes will contain inflation and actually strengthen the economy, along with the stock market.

The rising volatility in U.S. and worldwide stock markets is because Bernanke is off message. The U.S. Fed calls the tune for world money. Right now, the tune is off key.

Until Mr. Bernanke gets back on message, with clarity, expect more market volatility.

Again, the message should be: price stability, price stability, price stability.

May 17, 2006

Fed Must Get Back On Message - by Larry Kudlow

U.S. Treasury undersecretary Tim Adams told me on CNBC Monday night that he does not believe trade deficits have any strong impact on currency rates. Nor are they interested in "beggar-thy-neighbor" currency policies.

From this, I take away the thought that the Treasury may not really be trying to manipulate the dollar lower. Using a thirty nation index for the dollar, there really is not much decline at all following a massive run-up during 1991-2002.

Given the U.S. investment boom, as illustrated by yesterday's strong industrial production numbers, I would be a dollar buyer, not a seller.

Here's a thought for you inflationists out there: The business and investment boom sparked by lower tax rates three years ago will, over time, burn off any excess monetary calories. Lower tax rates are always associated with lower inflation. Lower tax rates raise the demand for money.

Ben Bernanke needs to do two things right now to calm inflation worries. It's real simple: First, get back on message by repeating his earlier mantra of the need for a numerical inflation target. This would reestablish the price rule.

Second, the Fed should keep raising their target rate in quarter point intervals, until the breakeven inflation TIPS spread drops down about 25 or 30 more basis points.

Fed policies have slowed the monetary base. Keep up this campaign.

May 15, 2006

'Intellectuals' Pining for Higher Tax Rates

The Washington Post's Sebastian Mallaby is on a crusade to discredit pro-growth or supply-side economic policies. Today's column titled "The Return of Voodoo Economics" makes one wonder about what he doesn't like about 4% growth, under 5% unemployment, housing and the stock market higher, wealth being created and tax revenues at all time highs. I guess he pines for the pre-Voodoo Economics days of the 1970's when the highest marginal tax rate was 70% and the country had anemic growth, high unemployment and a Dow languishing below 1,000.

What gives Mallaby the right to think that he is a "serious" person when it comes to economic policy, but President Bush, Vice President Cheney, Majority Leader Frist and Finance Chairmen Grassley are not? Is Mallaby really that arrogant? Did it ever occur to Sebastian that maybe he is letting his ideological views get in the way of an honest appraisal of the facts?

Why is it so hard to explain the concept to many "intellectuals" that the idea is to grow the pie as big as possible, and that taking a smaller percentage of a bigger pie can yield more than a higher percentage of a smaller pie? Mallaby can quote all the economists and studies he wants to justify his attack on the economic wisdom of lower tax rates.

I'll just look at what happens in the real world.

Nations that pursue pro-growth economic policies and expand their economy at 3%-4% a year (or more) create wealth and a better life for their people, and also generate considerably more tax revenue to their governments. Nations that stifle economic growth with policies of high regulation and high taxes, create less wealth and less tax revenues for their governments.

Why has Chile prospered for 25 years, while Argentina languishes? Why are the treasuries of Hong Kong and Singapore flush with revenue? Why have the U.S. and Britain shown tremendous growth since Reagan and Thatcher while Continental Europe with their pseudo-socialism putters along with chronic double-digit unemployment? Go around the world these last 25 years and compare nations with high tax rates to countries with low tax rates, you'll find a pattern.

Growth produces wealth, which leads to higher tax revenues and a more prosperous nation. Less growth produces less wealth and in turn lowers tax revenues. High tax rates retard economic growth; low tax rates encourage more growth. It really isn't that complicated.


May 01, 2006

The Economic Boom Will Continue - by Brian Wesbury

Despite a great deal of pessimism, the US economy is booming. Real GDP grew by 4.8% in the first quarter, while "core" real GDP (consumer spending plus fixed investment) expanded at a 6.4% annualized rate. Excluding the volatile transportation sector, durable goods new orders surged 2.8% in March and are up 9.6% in the past year. Sales of both new and existing homes exceeded expectations in March, while commercial and industrial loans have expanded at a 14.5% annual rate during the first three months of 2006. For April, Wal-Mart blew away expectations and reported 6.8% same-store sales increases.

The reasons for this boom are entirely understandable. First, the US is experiencing an unprecedented period of productivity growth as technology proliferates. Second, tax rates on long-term capital gains and qualified dividends were dialed back to 15%in May 2003 - which turned on the entrepreneurial spirit almost instantaneously. Third, monetary policy remains accommodative, a fact that has been widely, and wildly, underappreciated.

Even though most people think of the Fed in terms of interest rates, in reality the Federal Reserve only controls one policy tool - money. When the Fed adds money to the economy, the growth rate of nominal GDP (otherwise referred to as total spending or aggregate demand) accelerates. When the Fed subtracts money from the economy, nominal GDP growth slows. In short, the amount of money in the economy determines the level of spending.

Nominal GDP slowed from roughly 6% growth in the late 1990s, to a deflationary 3% in the early 2000s. Since 2002, nominal growth has accelerated to its current rate of 6.7%. This acceleration in nominal GDP growth is an obvious signal of accommodative monetary policy. Rising commodity prices and a falling dollar also indicate that the Fed has been adding more liquidity than the economy really needs.

Historical relationships show that a growth rate of 6.5% in nominal GDP means that the neutral federal funds rate is somewhere between 5.5% and 6.0%. The longer the Fed holds rates below that level, the faster nominal GDP will grow, which in turn drives up the level required to be "neutral."

The bottom line is that the Fed is still accommodative. In addition, technology and tax rates are positive forces boosting the economy. For this reason, the economy is highly unlikely to slow as the conventional wisdom believes. The boom will continue.

(Brian Wesbury is the Chief Economist for First Trust Advisors in Chicago, IL)

April 26, 2006

Free Markets Work - by Larry Kudlow

The greatest story never told? It's still the booming American economy--spurred by lower tax rates, accommodative money, huge profits, big productivity, plentiful jobs and a general free-market capitalist resiliency.

Some folks are bellyaching and gnashing their teeth about oil and housing; but you know what? Housing is softer but is holding up just fine. Today's Wall Street Journal says its time to buy a home in Houston, Dallas and Atlanta, rather than the east and west coast. Good point. As for gas at the pump, it averaged about $2.40 in March and about $64 for crude oil. But this was not an economic impediment. Production, retail sales, and employment were all very strong in March. Very strong indeed.

Today's durable goods report was off the charts strong. Airplanes, transportation, metals, industrial machinery, computers, even motor vehicles and car parts. But wait. The key point: business investment in capital goods was unbelievable. New orders for core cap-ex, (ex defense and aircraft) have grown 9 percent at an annual rate and 12 percent over the past year. That is a leading indicator of future business spending.

And there's more. Backlogs of unfilled orders increased over 12 percent at an annual rate in the first quarter--the best in two years. This key measure is a leading indicator of the new orders leading indicator, a very important forecasting tool for business economists. With this kind of real world corporate activity in the pipeline, it shows that highly profitable businesses will be doing a lot of hiring in the months ahead in order to expand plant and equipment capacity. Just what the doctor ordered.

At these lower tax rates, capital is still relatively inexpensive and investment returns are unusually high. What's more, President Bush's mid course correction on energy policy is going to stabilize, or even reduce, upwards pressures on the price of oil and retail gasoline.

Regrettably, Mr. Bush included a lot of liberal-left greenie gobbledygook about price gouging inspections and oil company investments. But he may have included that to stop a windfall profits tax from coming out of Congress.

Continue reading "Free Markets Work - by Larry Kudlow" »

April 25, 2006

Oil Update - by Larry Kudlow

President Bush did himself some good by suspending the ethanol tax--at least for the duration of the driving season. He also did some good by stopping the fill rate for the Strategic Petroleum Reserve. Gas prices slipped lower today, as did crude oil.

The biggest factor in rising energy prices is still the world economic boom. And of course, various political saber rattling from inside nuclear ambitious/anti-Israel Iran and leftist President Hugo Chavez's Venezuela. But around the edges, the president's mid-course correction for energy policy will at least stabilize the situation as everyone then waits for the upcoming hurricane season.

One action President Bush should have taken (and could still take) is to end the 54-cent-a-gallon tariff on imported ethanol (which basically means Brazilian ethanol.) Why the U.S. government should protect the already heavily subsidized ethanol industry at the expense of American consumers is hard to fathom.

Energy Secretary Sam Bodman actually defended the tariff earlier this month saying it was necessary so that foreign producers "can have no advantage over American companies." Holy smokes, this is the energy version of steel tariffs and it's just as bad an idea.

But all this talk of price gouging is nothing more than the usual political pabulum.

April 24, 2006

How We Would Get Tax Reform

Great suggestion from a reader.

Here's an idea that Treasury should consider in any tax reform. Two rules:

1. All representatives and senators shall do their own taxes; and

2. All representatives and senators shall have their returns audited.

You'd see how fast the tax code would get simplified.

April 18, 2006

Larry Kudlow: Bush's New OMB Director

I may have been too hard on Rob Portman, according to supply-side House member Paul Ryan. Paul served on the Ways and Means Committee with Portman, who favored supply-side tax cutting and was tough on spending. Though soft-spoken, Portman was always an ally of the conservative Republican Study Committee, but not a member because of his leadership position in the GOP caucus.

Mr. Portman favors personal savings accounts for Social Security reform and lower tax rates on cap gains and dividends. He also favors budget earmark reform; and in general, wants to stop the Appropriations Committee people like Chairman Jerry Lewis from running away with pork.

Portman is described as non-confrontational and never really on the front lines of conservative activism such as folks like Mike Pence, Jeff Flake, John Shadegg and other RSC members. Unlike them, Portman did vote in favor of the Medicare prescription drug bill, the No Child Left Behind education bill and the restrictive McCain-Feingold campaign finance legislation. However, he is a free trader (he voted for CAFTA and NAFTA) and he did vote against the big farm subsidies bill.

Essentially, it appears that Rob Portman is an establishment Republican with good tax and budget instincts who was close to the Republican Study Committee movement.

The problem in the White House, however, is that during the Andy Card regime, key policies were developed in the West Wing and then sent over to OMB on spending and to Treasury on taxes. This robbed those two important agencies of any real creativity to launch strong policy initiatives and then fight for them in the White House.

During the Reagan years, OMB under David Stockman sent over hundreds of budget cutting ideas to the White House, many of which were adopted as policy and subsequently implemented legislatively. Most of this occurred in 1981-82, but later on Jim Miller pushed for Gramm-Rudman as a spending limitation developed in OMB. That was subsequently adopted.

So the question is whether really tough budget cutting ideas can begin with Portman's OMB and then sent over to the White House for a far more aggressive budget cutting strategy. My suspicion is that John Snow in Treasury would have pushed for full-fledged tax reform, but the White House had no interest and therefore stopped this process. Whether the Josh Bolten West Wing operation gives greater latitude to Treasury and OMB remains to be seen.

April 17, 2006

Eat, Drink and Be Merry, But Don't Sue

The Indianapolis Star has a good editorial on the need for legislation to shield food and beverage companies from frivolous lawsuits:

Tony the Tiger, Ronald McDonald and even Virginia dairy farmers have been targeted by lawsuits filed by people who blame their obesity on eating Frosted Flakes, Big Macs and milk. Who's next? Grandma in the kitchen making cherry pies and chocolate chip cookies?

Not if Congress has the sense to pass the Personal Responsibility in Food Consumption Act -- better known as "the cheeseburger bill." It would prohibit lawsuits claiming that a food manufacturer or fast-food outlet is responsible for an individual's weight gain......

The real responsibility for obesity needs to be placed where it belongs -- on the consumer who makes choices about what to eat and how much to ingest.

The victimhood culture in America helps propagate these insane lawsuits which serve to line the pockets of trial lawyers at the expense of Joe and Jane public who has the cost of defending against this litigation passed on to them in the form of higher prices and fewer jobs.

April 12, 2006

Larry Kudlow: The Huge Ball and Chain

Americans will work for 116 days this year--almost 1/3 of the entire year--just to earn enough money to pay their tax bill to the IRS.

To put that into perspective, Americans currently spend four months out of the year working at our jobs before we get out from underneath the government's tax stranglehold. So, socking away your dollars for your kid's college education, saving up for retirement or a new home, putting away your hard-earned money for a vacation, a new car or rainy day -- well that can all wait. Like it or not, Uncle Sam's got you by the neck for four months-what you choose to do with the other eight is up to you.

To compound matters even more, Tax Freedom Day - the day when your money finally goes into your bank account rather than the outstretched hands of politicians - comes three days later than last year and ten days later than 2004. And Democrats want to raise our taxes even higher.


This pillage and plundering of American wallets becomes an even tougher pill to swallow when we witness the extraordinary waste of our hard-earned money towards earmarked pork like the infamous $223 million Alaskan "bridge to nowhere."

The natives are growing restless. As The New York Sun points out today ("Real Bracket Creep") Americans are fed up with the current system and politicians better start paying attention. Citing the latest non-partisan Tax Foundation report that revealed an astonishing 80 percent of U.S. adults believe the current federal income tax is somewhat or very complex, the paper points out the following examples of voter disgust:

· Almost 60% said they thought the amount of federal income taxes they personally pay was too high.

· 40% of Americans said the federal tax system "needs major changes," while another 40% said it "should be completely overhauled."

· Just 2% described the federal tax system as "fine the way it is" and only 1% of those polled said the current federal income tax is "not complex at all," (Who are these people?)

· When asked to choose between a flat-rate income tax with no deductions, a national sales tax, or the current graduated income tax with deductions, 33% chose a flat tax, 20% favored a national sales tax, and 21% preferred the status quo.

Let's be clear here: The tax system is a huge ball & chain tied to the feet of hardworking American entrepreneurs and ordinary workers and savers. They can barely get to work or invest because of this enormous weight. But if you remove this ball & chain, you can bet your bottom dollar that we will witness another growth explosion--one that could raise our potential to grow by 5 percent a year and would generate tax revenue at a lower flat tax rate of around 20%.

Enough already.

April 06, 2006

Conference Committee to Extend Cap Gains and Dividend Tax Cuts to 2010

We are hearing from our sources on Capitol Hill that the House/Senate Conference Committee has reached a compromise that will extend the 15% maximum tax rates on long-term capital gains and qualified dividends through 2010. Currently, the lower rates are set to expire on December 31, 2008.

Sources tell us that this compromise should be made public tomorrow, and will include a two-year extension of the 15% maximum tax rates (through 2010), a one-year Alternative Minimum Tax hold harmless provision (through 2007), and incentives for small business investment.

Recent gains in US equity prices have likely been driven to some extent on the increasing likelihood of just such a compromise. An extension of the 2003 tax cuts should give them another boost. However, the real benefits will unfold through the end of the decade. When the tax cuts first became law in May 2003, business investment accelerated significantly. Low tax rates on investment encourage more entrepreneurial activity, which is an unqualified positive for the economy as a whole. We assess the likelihood of an extension at 80%.

(Brian Wesbury is the Chief Economist for First Trust Advisors in Chicago, IL)

March 27, 2006

Pessimism, Optimisim and Freedom - by Brian Wesbury

Ever since the current recovery began, a disconnect between the economy's performance and the public's perception of that performance has existed. Time has not closed this gap.

According to a survey sponsored by the American Research Group, taken between March 18th and 21st, only 40% of Americans rated the national economy as excellent, very good or good, while 59% thought it was bad, very bad or terrible.

When these very same people were queried about their own household finances, 65% said they were excellent, very good or good, while just 32% thought them bad, very bad, or terrible.

People seem to think they are doing well, but their neighbors are not. With unemployment down to 4.8%, the stock market up, interest rates low, incomes and wealth growing, and the economy expanding solidly, this divergence in opinion is hard to fathom.

Part of this disconnect is due to an unending onslaught of negative news about the economy. Certainly, there are some bad things happening. Hundreds of thousands of workers at auto and auto parts manufacturers face an uncertain future. These problems come on the heels of major problems at large US airlines. But, a great deal of the fear about our economy comes from a group we call the Pouting Pundits of Pessimism who see potential calamity behind every bush and around every corner.

Illegal immigration, low savings rates, bird flu, terrorism, foreign enmity of the US, slow wage growth, high energy prices, Fed rate hikes, China, global warming, pension problems, budget deficits, and trade deficits are not an exhaustive list.

It is impossible to analyze each of these "issues" in such a short space. In brief, however, the last time we can remember so much negativity was in the early 1980s, when Japan and Germany were "stealing" all our manufacturing and pundits fretted constantly about deficits, savings and wage growth.

But, in the 1980s and 1990s, the US economy continued to grow much faster than other developed countries. The same is true today. The US is growing two or three times faster than Germany or France, a record number of people are employed in the US, average hourly earnings have expanded at a 4.8% annual rate in the past three months, and household wealth has hit an all-time high. Moreover, in February, the Federal Reserve's manufacturing output index rose to a record high - the US manufacturing sector has never produced more "stuff." China is not stealing all our manufacturing.

The data speak for themselves, but so do the polls and surveys. Despite a good economy, people are worried. The "old" ways of doing things are giving way to "new" ways. For many, these changes cause consternation and fear.

This is unfortunate. The US has been the world's most successful economy for nearly two centuries. The reason for this has been a focus on freedom. Immigration, free trade, low taxes and limited government interference are the signposts of this freedom. Any deviation from that path threatens that success.

(Brian Wesbury is the Chief Economist for First Trust Advisors in Chicago, IL)

March 16, 2006

We Are Doing Just Fine - By Larry Kudlow

If things are so bad according to the polls, why are they so good according to the stock market?

I am one of those who believe that stocks are the best barometer of the health and wealth of our nation, and our nation's businesses. Poll after poll keep telling us how unhappy people are with the President Bush, the economy, the Iraq war, and the direction America is going in. Yet stocks are telling a decidedly different story. They are making five-year highs among the broadest averages, a completely different message altogether.

Some important indexes like the NYSE (about 2500 stocks), the Transportation Index and the small-cap Russell 2000 are registering all-time highs. Today's inflation report shows diminished price pressures. With respect to interest rates, the Wall Street rumor mill is discounting "one and done," or at most, only two more Fed rate hikes to 5 percent. Profits continue their surge, consumers are spending, and the economy is healthy.

My guess is large-scale troop withdrawals from Iraq are already in the planning stage. The U.S. military knows what it's doing, and President Bush is listening to them. We are about to open up new talks with Iran concerning their mischief in Iraq, and you can bet these talks will include nuclear weapons as well.

With all due respect to the many fine pollsters out there, I'll take the stock market as a better indicator of American health and wealth.

We are doing just fine.

- Larry Kudlow, Host of CNBC's Kudlow & Co.

March 13, 2006

The Real Threats to the Economy - by Brian Wesbury

The current recovery began in November 2001 and is 52 months old. Growth in the first 18 months of the recovery was anemic, with real GDP rising just 2.1% at an annual rate. Ever since the May 2003 tax cut, however, the economy has boomed and real GDP has grown at an average annual rate of 3.9%.

Business investment in equipment and software fell an annualized 1.4% during the first 1 1/2 years of the current recovery. Since the tax cut, equipment and software investment has accelerated to an 11.1% annualized rate.

Between November 2001 and May 2003, non-farm payrolls contracted by an average of 58,000 jobs per month. In the past 12 months, the average gain is 171,000 new jobs, while in the past 4 months, payrolls have added 228,000 per month.

Despite this convincing evidence that the tax cut worked, and that the economy has consistent and robust forward momentum, there are still many who feel as if this economic recovery is fragile.

The laundry list of worries is long: High and rising energy prices, a large and growing trade deficit, budget deficits, rising interest rates, a slowdown in housing, consumer debt levels, layoffs, and pension problems make up part of the list.

But, none of these so-called problems has ever killed a recovery in the past, despite the fact that they have been feared for a very long time.

Our forecasting methodology concludes that there are really only four threats to the economy that investors should worry about: 1) Tax hikes. 2) Protectionism. 3) Government spending and regulation. 4) Bad monetary policy.

Right now, monetary policy is not a threat. We continue to believe that a neutral federal funds rate is near 5.5% and we doubt the Fed will push rates beyond that level. However, the economy could be hurt either way - if the Fed tightens too much, or does not tighten enough.

Tax policy is in good shape, at least through 2008. While an extension to the current 15% investment tax rates is important, as long as the low tax rates are in place the economy will do fine.

On the other hand, rising government spending and expanding regulation are a burden on the economy. Protectionist sentiment is also on the rise.

Currently, low tax rates and a reasonable Fed policy outweigh any negatives from the other threats and we continue to forecast strong economic growth well into 2007. For any change to this forecast, look to the four threats, not a laundry list of fears.

-- Brian Wesbury

(Brian Wesbury is the Chief Economist for First Trust Advisors in Chicago, IL)

March 01, 2006

Laffer Curve Redux

The Wall Street Journal story “Tax Receipts For Capital Gains Were Strong in ’04” once again illustrates the validity of the Laffer Curve. And, early projections indicate the trend continued last year in ‘05.

At the new 15 percent reduced tax rate, taxpayers realized $479 billion in cap-gains in ‘04 compared with the $381 billion predicted by the Congressional Budget Office. Hence, government cap-gains receipts came in at $60 billion, compared with the $48 billion estimate. In 2005, the CBO preliminary guess is $75 billion in receipts, a big 25% increase over ’04.

As Art Laffer has taught us all, if you tax something less, you get more of it. This includes capital and labor. But the purest form of the Laffer Curve involves investment taxes, where economic behavior is incredibly responsive to changing tax rates. The new CBO report bears this out.

My guess is when the “official scorekeepers” get around to the dividend tax cut; that one will also pay for itself.

As Congress debates final passage of the investor tax cuts, legislators are nuts to assume static revenue loss when all the evidence shows a revenue gain.

But the good news is all indications are that the investor tax cuts will, in fact, be extended two more years in the budget reconciliation bill. This is undoubtedly a key reason why stocks have gotten off to their strongest first two months of the year since 1998, according to this morning’s WSJ.

- Larry Kudlow, Host of CNBC's Kudlow & Co.

February 16, 2006

The Bush-Bernanke Rally

Call it the Bush-Bernanke rally.

After two days of Congressional hearings, new Fed chairman Ben Bernanke delivered a “not-too-hot” and “not-too-cold” testimony that reassured financial markets, driving up share prices by roughly one percent across-the-board, while gold, bonds and the dollar were flat.

Meanwhile, for the first time, the Senate voted 53-47 this week in favor of extending President Bush’s investor tax-cuts on dividends and capital gains. Senator John McCain, who voted against these tax cuts in 2003, voted for them this week. That is important news for the GOP Presidential frontrunner.

During his hearings, Ben Bernanke gave the Bush tax cuts credit for economic recovery. Mr. Bernanke also pledged to keep basic inflation around 2 percent or less, and he narrated a positive view of the economy.

His biggest concern on the inflation front seemed to be a spillover effect from higher energy prices. But that hypothetical thought is being overtaken by events in the energy trading pits, where gasoline prices are plummeting and crude oil has dropped below the $60 dollar a barrel threshold. With energy inventories high, lower prices will pull down inflation rates in the next couple of months.

Lower gas prices at the pump are increasing the purchasing power of rising consumer incomes from steadily impressive job gains. This is what the housing pessimists are missing. Any cooling of the home real estate market and the cash-out income value from that market is being more than offset by falling unemployment and rising income from the job creation of healthy American businesses.

The best part of Bernanke’s testimony was his reference to the Wicksellian real-interest rate model, calculated through the difference between inflation indexed bonds and cash bonds. These forward-looking bond market indicators tell Bernanke that inflation worries are “well anchored,” and that the Fed’s interest rate target will move to neutrality at 4.75 percent, or more likely, 5 percent in the next couple of months.

The worst part of the Bernanke performance was his lingering references to resource utilization and “excess” economic growth above potential. Remember, in the second half of the 1990’s, unemployment dropped to 3.9 percent, while real economic growth averaged above 4 percent, without upward inflation pressures. The Fed’s aggressive over-tightening in 2000 led to a generalized deflation of commodity and equity and business investment. This was Greenspan’s biggest mistake, predicated on a short-run Phillips Curve trade-off which gave the Central Bank a very bad policy signal.

Hopefully Bernanke will stick with the bond indicators, bolstered by commodity and currency market signs, and will push the Phillips Curve into the background where it belongs. Otherwise, this old Soviet Gosplan approach to central planning will doom the recovery cycle.

Fortunately, Mr. Bernanke will be ably assisted by two new Fed board appointees--Kevin Warsh and Randall Kroszner--both of whom were unanimously approved today by the Senate Banking Committee. Full Senate confirmation will occur in due course. As I’ve been saying all along, George Bush has moved the Fed’s center of gravity toward free-market, supply-side economics.

Notably, Bernanke not only credited tax cuts for economic recovery, he also endorsed school choice and vouchers for better education performance. And he also contended that private market companies, not government, should underwrite terrorism risk insurance.

It’s safe to say that the “old guard” Fed bureaucracy--led by Donald Kohn--doesn’t like this free market assault one bit. They were the ones leaking potshots at young Kevin Warsh, (the Harvard trained lawyer, former investment banker, and senior policy advisor, who will be the only person in the Fed building with any real world financial market experience and contacts).

So, the Bernanke revolution is just beginning. No major news or radical departures were broken during his first two days in front of Congress. Stock markets are looking through the next couple of minor rate hikes toward pro-growth policies and a profitable continuance of the economic expansion.

It’s a good beginning.

More on Tax Reform

The Club for Growth's Andy Roth penned a pithy column called "Tax Competition" that echoes the thoughts I recently expressed in my blog "Voting with Their Feet". Here it is:

"Do liberals believe in tax competition? Do they recognize that it exists? This is a serious question and I honestly don’t know the answer. They probably believe on some level that it does exist, but since it doesn’t mesh well with their overall philosophy, they choose to ignore it.

I bring this up because I came across this article about how the Swiss are cutting tax rates to compete against Ireland and the EU.

Consider an example: Two towns border each other. Town A has a sales tax rate of 8.125%, while Town B has a sales tax rate of 5%. Is it not common sense to assume that people will spend more money in Town B, and as a result, Town B will collect more in tax revenue? (this really happened)

Fact is, liberals need to admit that incentives really do matter. People prefer to be taxed less than to be taxed more. They don’t overpay their tax returns (not even John Kerry does that) and businesses like areas where taxes are low, even if that means going overseas.

We can move mountains if liberals concede that fact. Let’s agree to simplify the tax code and slash rates, or even abolish the income tax and move to a low national sales tax.

Once we agree on that, then we can debate the old argument about tax fairness until everyone is blue in the face. But, the point is that everyone needs to recognize that the Laffer Curve is a mathematical verity. Until then, liberals will continue to look like ostriches with their heads buried in the sand."

November 14, 2005

The Unthinkable Becomes 'Inevitable'

From the Detroit Free Press on Friday:

November 11, 2005


General Motors Corp. is unraveling -- fast.

Its stock price plunged to a 13-year low Thursday after the latest in a string of financial problems dismayed shareholders once again.

Wall Street experts say the unthinkable is more likely than ever before: Michigan's largest company could be bought by a corporate raider like Las Vegas billionaire Kirk Kerkorian, forced to file for bankruptcy, or both. [snip]

Experts say a buyer like Kerkorian could sell GMAC (the division that lends money for everything from cars and homes to Manhattan skyscrapers) for $10 billion to $15 billion, take GM's $15 billion in cash and stock, put GM's automaking business into bankruptcy, and walk away with a huge profit.

In a note to investors on Thursday, Bank of America said bankrupcy for GM is now "inevitable." It looks like GM's day of reckoning is approaching faster than most thought, and it will be extraordinarily painful when it arrives. GM workers agreed to a first round of cuts over the weekend, and the company announced a new "red tag" promotion today to try and boost sales, but the writing is on the wall.

On a related note, two weeks ago The New York Times ran a predictably biased article bemoaning the decline of African-American union membership under the headline "Labor's Lost: For Blacks, A Dream in Decline." Here is an excerpt (reg req):

Immigration, retirement, automation, the shifting of work overseas, low seniority and privatization have all played a role in the lopsided decline of unionized jobs held by African-Americans. That decline is especially noticeable in manufacturing and the federal government, two strongholds of black employment that have gone through cutbacks in union workers in recent years.

The cutbacks are particularly severe in the auto industry. In addition to the latest problems at G.M., Ford Motor said Thursday that it would soon announce ''significant plant closings.''

The impact on blacks has gradually drawn the attention of labor leaders, including John J. Sweeney, president of the A.F.L.-C.I.O. ''The percentage of black workers who have been knocked out of union jobs is one of the little-known tragedies of the last five years,'' he said.

The flipside, of course, which The New York Times fails to mention is that African-Americans are thriving in non-unionized factories all across the South like this brand new $1.1 billion Hyundai plant in Montgomery, Alabama.

Not too long ago a good friend of mine who works for a GM supplier in the midwest spent roughly two months on assignment at the Hyundai plant. His report: more than 90 percent of the workers on the floor are African-American. Wages are high for the region - but still only half of GM workers in Michigan and Wisconsin. The cost of living is low. Health benefits are excellent. And - here's the kicker - the quality of the work is five to ten times better. The result is that Hyundai is kicking Detroit's butt with a higer-quality, lower-priced car made right here in the USA.

October 24, 2005

Bernanke for Federal Reserve Chairman

Larry Kudlow calls the Bernanke nomination "a good choice" and is happy that Greenspan's reported preference of Donald Kohn to be his successor was rejected:

Thank heavens that Fed board member Donald Kohn, who is a demand-sider and a Phillips Curver, did not get the nod.

After the disastrous Miers nomination the President had little room for another screw up. Bernanke's a solid choice similar to the Roberts nomination and should be confirmed easily. More importantly he should also be a solid successor to Alan Greenspan.