Well, today is Fed day, and virtually everyone expects a pause at 5.25 percent. From a supply-side point of view, however, the issue is not as clear-cut. It really boils down to who do you trust: bonds or gold?

The bond market is telling the Fed to pause with long rates dropping below short rates. On an inflation-indexed basis, the yield curve is also inverted. This suggests tight money and a recessionary economic threat.

Gold is sending an entirely different message. While down from its May peak of around $750, gold is trading a little over $650. A year ago, gold was close to $450. Of course the flip side of gold is the dollar, which is also trading weaker. It’s almost impossible to reconcile the different messages of bonds and gold.

To some extent, gold is moving with oil, where the September oil contract is just under $77, up from about $58 last December. Perhaps both gold and oil are trading on geopolitical risks, primarily from the Middle East. But if money were truly scarce, you can’t help but wonder why both of those commodities are still so high.

Inflation expectations, measured by the TIP spread, are around 260 basis points, about 40 or 50 basis points higher than year ago. Again, if money were really scarce, one would think the breakeven inflation spread would be narrower.

The economy is not nearly as weak as the Keynesian demand-siders would have us believe. Economic growth looks to be moving toward 3 percent, but the split inside nominal GDP has moved toward higher inflation and slower real output. That’s the real crux of the Fed’s problem. In the second quarter GDP, inflation ran faster than real growth. A touch of stagflation, if you will.

My preference would be a 5.5 percent fed funds rate, then a pause after that.

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.

“…Poll after poll shows that American voters are not happy about Iraq for any number of reasons, with most of the anti-war media focusing its commentary on the White House and Pentagon. But Congress plays a key role in this war through its oversight functions, and if more stories like this circulate in the media, Congress will be blamed.

What we sorely need now is a Harry Truman.

When Truman was an unknown senator from Missouri during WWII, he chaired hearings that rooted out corruption in various war-related contracts among defense suppliers. In doing so, he made a real name for himself as a corruption fighter, prompting FDR to put him on the presidential ticket in 1944.

Truman’s panel was called the Senate Special Committee to Investigate the National Defense Program, but from the start it was known as the ‘Truman Committee,’ according to historian David McCullough. The senator held numerous hearings in Washington, and traveled all over the country gathering facts and figures on the building of ships, warplanes, and various plants. He investigated giant corporations, small businesses, and unions, turning up all manner of bad planning, sloppy administration, poor workmanship, and cheating by labor and management.

For Truman, this was all part of being a pro-war patriot, and by 1943 his committee had produced 21 separate reports. McCullough points out, ‘unquestionably, [Truman's] relentless watchdog roll . . . greatly increased public confidence in how the war was being run.’

Public confidence? With public confidence in the Iraq War plummeting today, I can only ask, ‘Where is today’s Harry Truman?….’

-From my latest column at National Review Online.

Today’s employment report confirms a modest slowdown in the economy, though there’s nothing to panic about and there’s no recession in sight.

Nonetheless, Fed chairman Ben Bernanke’s slowdown forecast is confirmed by 113,000 new payroll jobs in July, about the same as the four-month average of 112,000. Household employment fell 34,000 in July, so its four-month average is stronger at 172,000. The unemployment rate advanced to 4.8 percent from 4.6 percent. Wages rose 3.8 percent over the past year and hours worked are 1.9 percent above the second-quarter average at an annual rate.

Clearly this four-month softer patch means that second-half growth will be closer to 3 percent than 4 percent. Still a pretty good pace. However, for those who are politically inclined, something called the misery index has been rising over the past four months and could be yet another bad omen for the GOP Congress in November.

The misery index combines CPI and the unemployment rate; its origins go back to the 1960s. You do not want to go into an election with a rising misery index.

Rising gasoline prices are the biggest driver of the index increase and now a slightly higher July unemployment rate adds to the misery. Despite a generally healthy economy, tighter money from the Fed over the past two years looks to be slowing the jobs story. And as I said, spiking gas prices at the pump are driving up inflation.

Low tax rates are still carrying business along on the investment front, but rising interest rates are hurting housing and both rate hikes and gas prices are slowing down the consumer. The GOP Congress is running about 12 percentage points down in the generic Congressional ballot and along with a deteriorating situation in Iraq, the rising misery index could be another nail in the GOP coffin.

No one knows if Fidel Castro is dead or alive. Maybe he’s in Venezuela conferring with Hugo Chavez. Or perhaps he’s in Iran with Ahmadinejad.

But where ever he is, Art Laffer has a plan to move capitalism into the new Cuba. First, dollarize the currency. Second, go to a Slovakian- or Baltic-type flat tax system. Third, open up free trade. Fourth, make a deal on private property rights with those whose property was expropriated by the state.

If it can be done in Eastern Europe, it can be done in Cuba. And remember there’s a lot of big Cuban money in Miami and elsewhere in the U.S. that will supply private investment to rebuild the new Cuba. This could even turn into a China situation where democracy may be lacking, but free market capitalism is permitted to evolve progressively.

Apparently the Bush administration doesn’t want to do business with Raul. But Mary O’Grady of the WSJ believes that Raul is ready to do business with the U.S., along with the Cuban military that is heavily involved in tourism and other business. So it strikes me that opening up trade relations with Raul would make a lot of sense.

This thought goes back to Tom Barnett’s idea of economic connectivity. Trade and investment relations are a great way to bring Cuba online and move them towards reforms.

The Republican Congress will be blamed for the widening corruption problems endemic to the Iraq War. It could be another nail in the GOP’s election year coffin.

Today’s WSJ story by Yochi J. Dreazen “Audit of Iraq Reconstruction Finds Corruption Worsening” is a very tough story that suggests a breakdown of Congressional oversight. Special Inspector General for Iraq Reconstruction Stuart Bowen’s latest quarterly audit estimates $4 billion per year corruption costs in Iraq. The story goes on to report that “the Bush administration continues to wind down its ambitious Iraq reconstruction program, which has spent ten of billions of dollars on rebuilding efforts that have largely failed to restore basic services such as water or electricity to pre-war levels.”

Oil smuggling continues to siphon off revenues. U.S. Comptroller General David Walker says 10 percent of Iraq’s refined fuels and 30 percent of its imported fuels were being stolen. Additionally, Mr. Bowen concludes that “the Bush administration’s overall handling of Iraq contracting — from relying on no-bid contracts even when major fighting had ended, to failing to standardize contracting regulations to help prevent fraud — was deeply flawed.” He goes on to say that the U.S. has not provided proper contracting and procurement support necessary to manage reconstruction efforts begun three years ago. And he also sites widespread mismanagement among competing U.S. government agencies.

Again, reports like this will damage Republican Congressional management and oversight of the Iraq war. Poll after poll shows that American voters are not happy about Iraq for any number of reasons. Most of the media commentary focuses on the White House and the Pentagon, but Congress plays a key role through its oversight functions. If more stories like this circulate in the media, Congress will be blamed.

When Harry Truman was an unknown senator from Missouri during WWII, he chaired hearings that rooted out corruption in various war-related contracts among defense suppliers. Truman made a real name for himself doing this. This is a key reason why FDR put him on the ticket in 1944.

Where is today’s Harry Truman in Congress?

I say all this as a war hawk and a war supporter. I want to win this war. I do not want to cut and run. I agree with President Bush’s basic mission of spreading democracy and freedom to the Middle East.

But after three democratic elections in Iraq, it does not seem that we are winning this war. And if we are not winning it, then one has to worry about the possibility that we may lose it. And that would be a very bad thing.

On CNBC’s “Kudlow & Company” tonight:

An all-star panel with Art Laffer, Robert Reich, and Steve Moore, will debate Treasury Secretary Hank Paulson’s speech, the Fed, and the economy.

Stefan Abrams of Trust Company of the West and Elizabeth MacDonald of Forbes will discuss their views of the stock market.

Mary O’Grady of the Wall Street Journal will give us her outlook on the Cuba/Castro situation after a brief update from our own Michelle Caruso-Cabrera.

Sen. Jon Kyl (R-AZ)on the estate tax cut and the minimum wage hike. Robert Reich and Steve Moore will weigh in.

Today’s Poll

Will Cuba move towards a new system of capitalism and democracy?

Yes or No

Reading through the new Treasury man’s speech, I am disappointed to find no tax reform as a key policy goal. There seems to be a lot of obsession with the budget deficit and long-run entitlement reform. Also, a mention of uneven income distribution.

The Bush administration ought to focus on tax reform, which is pro-growth. If they go to entitlement reform with all this silly talk about U.S. bankruptcy, it could be a big tax-hike trap as Democrats win more seats in the House and Senate. All these long-run entitlement estimates are wrong. They have low-ball growth and productivity assumption, which makes the problem look vastly worse then it really will be over the next 50 years.

Low tax-rates and an extended retirement age will solve Social Security. Betsy McCaughey believes the Medicare assumption are all wrong and are contributing to a fiscal hysteria, which is simply unnecessary.

The GOP should not lose their message of extended savings accounts, which reaches out to the investor class and will be a great wealth builder in the ownership society vision.

As for the dollar, Paulson says a strong dollar is in our nation’s interest and currency values should be determined in open and competitive markets in response to underlying economic fundamentals. In other words, essentially the same message as John Snow. I was looking for something stronger. Perhaps a hard dollar to contain inflation and promote price stability.

Paulson is clearly a free trader, which is great. And he does defend lower tax rates, which is also great. But I’m worried that entitlement reform will backfire.

For all we know, Castro may already be dead. The last Stalinist lion of the Cold War will be gone. Could it be that the whole Cuban Communist system implodes? Think velvet revolutions in Eastern Europe like Poland, Czech Republic, Slovakia, Baltics, etc.

This may be wishful thinking, but it is worth thinking about. Capitalism and democracy could come to Cuba a lot faster than we think. Or, Raoul Castro comes to power and starts doing business with the U.S. Mary O’Grady of the WSJ thinks Raoul and the military will want to expand trade and tourism, perhaps in return for freeing political prisoners and human rights dissidents who were jailed mercilessly in the 2004-2005 crackdown.

The Bush administration might lift the trade embargo in exchange for certain concessions. In that sense, the Cuba transition might be more like China. Ms. O’Grady believes that Raoul thinks that beans are more important than guns for the Cuban people. So maybe we can do business with them.

Art Laffer wants an Eastern Bloc-style privatization in Cuba with a low flat tax-rate and dollarization. Again, think Slovakia or the Baltics. There are breathtaking possibilities in all this. We’ll just have to wait and see.

Of course, the new real monster is Hugo Chavez, who wants to be another Castro. So far, the U.S. doesn’t have a clear policy toward Chavez and his oil-backed mischief. Russia is arming Chavez to the teeth. Venezuela is our biggest import oil source. Where’s the CIA now that we need them?

The U.S. stock market and world equity bourses are important measures of fear, hope, security, and the health of the world’s economy. And while you might not know it from today’s magnified headlines about war, terrorism, higher oil prices, and rising interest rates, the stock market message is one of reasonable hope, confidence, and optimism about the state of the world.

Could it also be that world stock markets are rallying as Israel and its freedom agenda advances toward a Hezbollah-free Lebanese border, highlighting a significant defeat not only of the thuggish and cowardly Hezbollah murderers, but their totalitarian backers in Syria and Iran?

At the close of business last Friday — after another violent week in the Middle East — Bloomberg chronicled the impressive performance of world stock markets: U.S. share prices had their best gain since November 2004; Canadian and European stocks had their top weekly performances all year; British and Brazilian equities rose for the second straight week; Asian stocks posted their strongest gain in over a month; Japan was up 3.5 percent; and India surged near 6 percent.

The wartime stock market is saying that things might be better than most people believe.

Think of it: On the world stage, there is more capitalism, free trade, and economic interconnectiveness (to use defense analyst Thomas Barnett’s term for bringing the worse-off countries online with the best-off nations) than ever before. Because of this, literally hundreds of millions of share-owning investors are voting daily on the great issues of war, peace, prosperity, and hope for the future. And their vote is optimistic.

Here at home, many groused about the 2.5 percent GDP report for the second quarter: Bears called it the first step into recession while bulls argued for a soft landing and an end to Fed rate hikes. But the whole debate may be misrepresenting a fundamentally strong economy. After all, GDP grew by 5.6 percent in the first quarter, making for a two-quarter trend of 4 percent growth. Over the last year, GDP is trending at 3.5 percent, which is pretty impressive for a fifth-year recovery buffeted by high gas prices, rising interest rates, and the uncertainties of war and terrorism. Since the June 2003 investor tax cuts, growth has averaged 4 percent.

While there are traces of higher inflation, non-energy price increases are still running just above 2 percent, about the same as 2004 and 2005. It’s also worth noting that inflationary expectations have been pulling back ever since the Fed’s May 10 rate hike to 5 percent and late-June hike to 5.25 percent. Gold prices are down about $100, inflation-sensitive commodity stocks have dropped 11 percent, and the bond-market yield curve has inverted again, with short-term rates popping above long-term yields. These are all non-inflationary signals.

In fact, the bond market is saying the Fed has tightened enough. A model of inflation-indexed bonds now shows the real fed funds rate to be above the real 10-year bond rate. This suggests that money is becoming scarce and that inflation is much less of a threat than it was a year ago.

Along with lower tax rates, strong profits, and ample bank credit, the entrepreneurial-driven growth model of the eminent classical economist Joseph Schumpeter is alive and well. Wall Street economist Michael Darda calls this ‘The wellspring of entrepreneurial capitalism, innovation, and wealth creation in the dynamic capitalist system.’ It’s also what Tom Barnett means when he talks about global interconnectivity. Economic freedom both inside and outside the U.S. remains a critical (though much underestimated) factor in the world economic outlook.

If freedom, democracy, individual liberty, and economic liberalization are all vital cornerstones of the successful City on the Hill experiment that is the United States, campaigns such as Israel’s only mark an expansion of this freedom. Israel may be a relatively small hill in global terms, but the battle it is waging is incalculably large on the world stage. As Israel inflicts more punishment on Hezbollah, the more Syria and Iran will have their Axis of Evil ears pinned back. This is a huge positive step for democracy and a big potential defeat for totalitarianism. Does the global investor class get it? How could it not?

For a long two weeks Israel and Hezbollah have been going at it hard, and world stock markets have chosen to climb. The backward-looking media pessimists won’t see this, but the real world, real money votes of the global investor class should be noted and digested by all the rest of us. Indeed, I believe world investors are thankful for Israel’s courageous efforts in the cause of freedom, independence, security, and hope for the future.

Of course, the stakes are very high in this game. But that is exactly why global investors are cheering Israel’s advance.

I was glad to see the The Wall Street Journal editorial page weigh in on the side of private property rights today (“The Kelo Revolt”):

’The Supreme Court has written some despised rulings over the years, but last year’s Kelo case is fast rising up the list of the worst. That 5-4 ruling gave local governments more or less unlimited authority to take private property, and the good news is that the political system is repudiating Kelo just about everywhere.

The latest venue is Ohio, where the state Supreme Court ruled Wednesday that a Cincinnati suburb cannot use eminent domain to seize private property for a $125 million commercial re-development. The states are acting at the invitation of Justice John Paul Stevens who, in his majority opinion for Kelo, wrote, “Nothing in our opinion precludes any State from placing further restrictions on its exercise of the takings power…”

Kelo was a dreadful decision.

It had anti-private property rights, anti-capitalist and anti-growth stains all over it, and the political system is repudiating it (as it should) just about everywhere.

Oklahoma’s Supreme Court repudiated it, now comes Ohio’s highest court, in addition to almost twenty states which have passed laws protecting property rights.

To put it simply: Kelo was un-American.

From The Weekly Standard:

’LAST SUMMER, in the case of Kelo v. New London, a bitterly divided U.S. Supreme Court upheld (and slightly expanded) the constitutionality of local governments’ seizing private property for economic development via the “takings power” of eminent domain. But in his majority opinion, Justice John Paul Stevens took care to insert this sentence in the closing paragraphs: “We emphasize that nothing in our opinion precludes any State from placing further restrictions on its exercise of the takings power.”

Wednesday morning, the Buckeye State did just that. In a unanimous 7-0 decision, the Ohio Supreme Court ruled in favor of Norwood property owners who were challenging the confiscation of their land through eminent domain. (Norwood is a suburb surrounded by Cincinnati.) It marked the first eminent-domain ruling by a state supreme court since Kelo, and will surely set a precedent for other states wrangling over this issue. “It gives guidance to courts for the future,” says Dana Berliner, a senior attorney at the Institute for Justice, which litigated the case in behalf of the appellants’

“…[M]ost of the peoples of the world — including the United States — still don’t believe that radical Islamist terrorism is a grave, worldwide challenge to civilization.

And therein lies our great strategic failure to date. So long as most people — certainly most Europeans, perhaps most Americans — see Islamist terrorism as merely the more or less disconnected actions of a relatively small number of fanatics, then Europeans will never send their sons to fight and die to defeat it. And, of course, they particularly won’t send their sons to risk death for the “Jewish state” of Israel or the “imperialist” United States. And who can ask any parents to risk sacrificing their sons for some foreigners — whether despised or not?

…Until the American and European publics have become convinced of the present danger to them, we will continue to stumble, take half measures and fail to adequately defend ourselves. Before action, must come belief; before belief must come understanding; before understanding must come education and debate. In the beginning was the word. It is time to begin.”

Tony Blankley, “Just Another Coincidence?”

(My friend Claudia Rosett delivers a scathing indictment of the U.N. at National Review Online today. Claudia knows the U.N. better than most and was brilliant in exposing the corruption behind the U.N.’s Oil-for-Food program. Her latest column is right on the money. Well worth the read…)

“As Israel fights to defend itself against the Iranian-and-Syrian-backed terrorists of Hezbollah, are we really seeing a reckless, damaging and ‘” yes ‘” disproportionate response?

You bet. But not from Israel. It’s coming from the U.N.

…With its false promises, and disproportionate deals for ‘peace,’ the U.N. left Israel exposed to the attack that has now come, and a war that Israel did not seek. Like America when attacked by al Qaeda, Israel has been fighting back. In response, U.N. officials have come close to trampling each other in their stampede to the media microphones ‘” not to admit the U.N.’s own failure to stop Hezbollah, not to apologize for administering a phony peace that incubated this miserable war, but to denounce Israel….

…And when operations of the U.N. itself have come under the spotlight in recent years, in some cases for behavior as egregious as pedophiliac rape by peacekeepers, or complicity in the kickback rackets of Saddam Hussein, Kofi Annan, and his entourage have rushed to impose the omerta in-house, while urging the rest of us to wait upon due process, refrain from rash comments, consider the larger picture ‘” and preferably just shut up and forget about it.

If Annan and his retinue feel a desperate need during this current crisis to express themselves, perhaps they should channel it into actually delivering some of that transparency they’ve been promising in their own operations. That would be good preparation in the event the U.N. Security Council decides, say, to impose sanctions on Iran, and needs the Secretariat staff to perform with at least slightly more integrity than was displayed under the Iraq Oil-for-Food program.

Right now it is the job of the world’s more responsible political leaders not simply to deplore the horrors of war, or construct another false U.N. peace leading to even worse nightmare ahead, but to seek real answers to the miseries and menaces of the Middle East. That is a task perilous, contentious, and rough enough, without a parade of unelected and largely unaccountable U.N. civil servants using public platforms to insinuate into the process their private prejudices.”

The war news is coming in fast and furious.

Let me first begin by noting that a month into the hostilities which started in Gaza, and a couple weeks after the outbreak of the Hezbollah war, the S&P 500 is actually about unchanged with a nice little multi-day move right in here, based on good profits, a solid economic outlook, and growing expectations that the Fed’s restraint cycle is nearing an end.

My spiritual pal, Mayer Rothschild, is right: ‘Buy on the cannons, sell on the trumpets.’

Another spiritual friend of mine, Joseph Schumpeter, is also right: low tax rates, strong profits, and plenty of bank credit for business entrepreneurs is a great combination for economic growth. Mike Darda calls this ‘the wellspring of entrepreneurial capitalism, innovation and wealth creation in the dynamic capitalist system.’

Relative to record earnings, and moderate, normal interest rates, U.S. stocks are significantly undervalued according to gurus like Art Laffer and Elaine Garzarelli. I totally agree.

Barring a $100 oil price, from some sort of bizarre Iranian action’”which can never be ruled out’”stocks and the economy will outperform the usual chorus of pessimism. It’s still the greatest story never told.

But, I digress from the war. Here are a couple points that stand out for me from all the news reports:

First, is a wonderful headline from the AP: ’Hezbollah Says Israeli Response a Surprise.’

Oh really? Tch-tch. It’s called fighting for your life. It’s called fighting for freedom and democracy. It’s called fighting against a bunch of terrorist thugs who want to wipe you off the face of the earth. It’s called fighting to enforce U.N. resolutions which Israel observed. It’s called searching for peace, but then fighting for your life when your enemy refuses to engage in any civilized peacekeeping.

The second point is, ’There can no longer be a Hezbollah,’ according to Israeli Foreign Minister Tzipi Livni, in a Der Spiegel interview published today. She goes on to say, ’[T]here is a very significant difference between us and our enemies: We are defending ourselves against anyone who attacks us and use every means possible to prevent hitting civilians’