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Kudlow’s Money Politics

Larry Kudlow’s daily web log of matters political and financial.

(Anti-) Mustard Seeds



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I’m going to get to mustard seeds in a moment, but let me first address two anti-mustard seeds: “bailout nation” and a pump-priming Fed. Bailout nation remains an ongoing issue. It really goes to the issue of government planning, industrial policy, and Uncle Sam picking winners and losers. This obviously includes Detroit, which we will probably get a decision on later this week.

Here’s a quote from President Bush that captures all my concerns about bailout nation: “I’ve abandoned free market principles to save the free market system.” Oh no. Say it ain’t so Mr. Bush. Either you believe in markets, or you don’t. Unfortunately, right now, the intellectual and policy tide out of Washington is anti-market. Not good.

As far as the Fed’s shock-and-awe, pump priming is concerned, I wrote about it yesterday. But already, the U.S. dollar is plunging. Gold is rising. How much will the Fed prime the pump? There’s no evidence that Bernanke cares one wit about the dollar. Not now, not yesterday, not tomorrow. If the greenback keeps falling, it can’t be good. I thought we learned that in recent years. Let’s not go to palm tress on the trading floor. A zero interest rate and massive pump priming reminds me of Argentina, not the United States.

Look, if we keep depreciating the dollar, the Chinese (our bankers), are going to boycott our bond markets. And then, at some point, longer-term interest rates are going to go up, not down. That includes mortgage rates.

The Fed’s balance sheet, reserve bank credit, is already expanding at 107 percent over the past 52 weeks. The monetary base is rising at a 41 percent pace. M1 and M2 at 8 percent. Money lags are long and variable, but there’s more than enough stimulus in the system. Banks have more than $500 billion in interest bearing excess reserves.  It’s enough already.

At least Harvard economist Greg Mankiw is being honest when he says the Fed should drop its price stability rhetoric and just come out and say it wants to raise the inflation rate to at least 2-3 percent.

But if we really want to jolt the economy, there’s a tried and true way to do it. Lower marginal tax rates across-the-board for individuals and businesses. Labor and capital costs will be reduced, risk taking and success will be rewarded, and investment will flow back into the United States. A chronically cheap dollar will simply repel investment, not attract it.

On the other hand, there are some positive mustard seeds that could grow into recovery. For starters, the drop in the CPI is boosting real wages. Of course that is an offshoot of the plunge in retail gasoline prices, which represents a $350 billion dollar tax cut for consumers. This may be why core retail sales rose ½ percent in November, the first positive reading since July. It’s also a big tax cut for corporate profits.

In fact, for businesses, the plunge in commodity prices in general has balanced out prices paid and prices received. The CPI/PPI ratio has turned positive in recent months. This is a very good sign for corporate profits. And it may be a key reason why stocks have been rising and why the November 20th bottom looks like the real bottom.

Another mustard seed is the big decline in the 3-month dollar Libor rate, along with declining short-term credit market spreads in general. There is a thaw in the money market freeze up.

Still another mustard seed is the decline in mortgage rates. This, along with lower home prices, has raised housing affordability to its best level in many years. In fact, as economist and Carpe Diem blogger Mark Perry recently pointed out, housing affordability has reached an all-time historical high.

In other words, the excesses of the recession are gradually healing. The mis-investment of the recession is gradually being absorbed. The Fed is adding liquidity and that is another plus. I just don’t want them to go hog wild and destroy the dollar in the process. If we maintain a steady currency and provide a much needed tax-rate reduction for large and small businesses, and if we allow market forces to work out the rest, then the economic patient will heal. That’s my message. 



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