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


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Larry Kudlow

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

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This is an important stance by the central bank, as our stock market is now well undervalued relative to the rising economy and improving profit picture. With steady long-term interest rates in place, the major index averages are 30% to 40% too cheap right now. Greenspan let us know that this disconnect is not the norm, and that investing America is standing on firm economic ground.

Importantly, Greenspan indicated that the Fed is likely to move the key fed funds interest rate up and not down. The promise of an upward adjustment — which most likely will not occur until the winter or next spring — means that Greenspan believes the economy is actually heating up.

As usual, the chairman made no mention of the Fed’s primary function — which is to create money. Literally, that’s just what the central bank does — it prints greenbacks — but Wall Street is left to guess how much new money is heading into the system. Judging by recent trends, the central bank could have sped up the printing presses in light of some headline bankruptcies (such as WorldCom) and the resulting shrinkage of asset values and investor wealth. Nevertheless, the Fed has been injecting new money into the system at an appropriately rapid 11% yearly pace, compared to roughly 5% a year ago. Consequently, gold and commodity prices have moved higher, signaling an end to deflation. On the whole, Fed monetary policy is currently pro-recovery.

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

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

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

Of course, there are glitches in the optimistic scenario. There always are. As Congress moves to deal with corporate corruption and accounting fraud, over-regulation becomes an economic threat. Some regulatory cost increases may be a necessary evil, but these could be offset with regulatory reductions — especially paperwork reductions — if legislators are interested in promoting economic growth.

Tax reforms could also help the corporate recovery. Ending the limited tax deduction on executive compensation would remove the incentive for stock-option grants that create harmful short-run stock-price boosting. Tax-deferred stock grants, held for the duration of employment, are a better idea.

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

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

We should also consider a turnover approach to capital-gains taxation: if a stock sale is soon reinvested, it shouldn’t be treated as a taxable event. This would keep the money in the market.

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

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



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