Back to Creation
There are more reasons to be bullish than bearish.


Larry Kudlow

Post-war economic commentary is, as usual, divided between the bulls and the bears. Many bears are quite bearish, predicting a double-dip recession. The bulls, however, aren’t all that bullish. Maybe 3% growth next year, they say, after another disappointing performance this year.

But there are a number of favorables out there that could generate a stronger economic-growth outlook. Remember, ours is a deregulated free-market economy. It is always more resilient than forecasters expect. The normal instinct of a free economy is to grow and prosper as entrepreneurs take risks to produce, invest, and create wealth. In Schumpeterian terms, we’ve had more destruction (of wealth) than creation in recent years.

Now’s the time to move back into the creation period. Growth barriers such as war, energy spikes, and unusually bad winter weather are crumbling. Fed money-adding has greatly reduced the risk of deflationary business pricing power. Interest rates are rock bottom. Productivity and profits are rising. Significant tax cuts to rebuild lost capital and wealth are in the cards.

If the problem in recent years was deflationary recession and an unusually long stock market plunge, then easier tax rates and accommodative money are the right solutions. So today’s policy mix is definitely pro-growth. This is quite unlike the last post-war episode — 1991-1993 — when tax rates were rising and money was relatively tight.

Markets are often smarter than forecasting models, and in this sense it is very interesting to see that the futures market for euro dollar deposit rates — which is heavily traded, efficient, and possesses all relevant information — is painting a much rosier economic picture than consensus forecasters.

Euro dollar future rates rise slightly in the fourth quarter, then climb by roughly 130 basis points in 2004, and then another 100 basis points in 2005. Using euro dollar rates in a market-based economic forecasting model, you get a very positive scenario of nearly 4% economic growth over the next two and a half years.

Modest interest-rate increases embodied in this scenario will actually hasten spending and investing decisions inside the economy. This suggests that a 4% economy with relatively stable prices and at least a 50% reduction in investor dividend taxes will be consistent with 20% stock market gains over each of the next couple of years.

Of course, futures markets often change their minds. But euro dollar rates have been sloping upward for many months now — before, during, and after the military victory in Iraq. It’s a good suspicion that these markets are discounting numerous positive policy and economic signs.

Remember, optimism is the American way. Keep the faith. Faith is the spirit.

Mr. Kudlow is CEO of Kudlow & Co.