Politics & Policy

Dynamism Vs. Demagoguery

Politicians represent the greatest threat to this ongoing economic expansion.

The first batch of February economic data has sent the weak-growth-Fed-is-close-to-done crowd running for the hills. The Institute for Supply Management’s Non-Manufacturing Index (ISM Services) jumped to 60.1 in February from 56.8 in January. (Consensus pegged February’s reading at 58.) This reading is consistent with 3.8 percent real GDP growth and is about in line with my own full-year 2006 forecast.

The ISM Services Employment Index rose to 58.2 during February, the highest since August 2005. This level is consistent with robust payroll growth and strong income gains on the order of 7 percent or more per annum. In other words, with inflationary pressures elevated, and labor markets likely to tighten further, the Federal Reserve almost surely will feel fully justified in pushing the federal funds rate to 5 percent by May and probably higher afterward.

Short rates probably are headed higher in Japan as well. The Japan core CPI advanced 0.5 percent year-over-year in January, the fastest pace in eight years. On a year-to-year basis, core prices have risen for three straight months. Against the backdrop of strong economic data and other signs of reflationary pressures (such as rising property prices and loan growth) speculation has mounted that the Band of Japan’s quantitative easing and zero overnight rate policy will soon be coming to an end.

Japan isn’t the only country where expectations for further monetary action have mounted. Two-year note yields rose to the highest level since 2002 in the European Monetary Union (EMU) last week on expectations that short rates will move higher this year. The European Central Bank hiked its benchmark Repo rate to 2.5 percent from 2.25 percent recently. However, with real short rates barely above zero in the eurozone, and now negative in Japan, central banks in both countries have a long way to go before monetary policy actually gets “restrictive.”

This is also evidenced by the fact that high-powered money growth in the eurozone is running at a 15 percent annual rate! One doesn’t have to be a strict monetarist to realize that near zero real short rates and double-digit money growth isn’t consistent with weak nominal demand — or price stability for that matter.

It is worth noting that the global bond market sell-off has occurred against the backdrop of record tightness in emerging-market credit spreads, which hit new all-time lows last week. And despite $60-plus a barrel crude oil prices, the Dow Jones Transportation Index reached another new all-time high last week. I think this tells us more about the health of the global financial system and the grassroots economy than the zero-sum accounting metrics that dominate the GDP statistics.

While the near-term growth outlook remains quite favorable, it makes sense to worry about an undercurrent of trade protectionism and xenophobia that seems to have infected both U.S. political parties like an anti-growth strain of the avian flu. Unveiled threats of currency manipulation — and proposals to impose punitive 27.5 percent tariffs if China doesn’t acquiesce to U.S. pressure to significantly raise the value of its currency — have continued.

Do politicians in Washington think it is worth short-term political points to seriously jeopardize our $200-plus billion trading and investment relationship with China? The fact that the key to a peaceful resolution to the Iran nuclear predicament ultimately may lie in our relationship with China — and Russia — means that submitting to the seduction of trade protectionism and zero-sum mercantilist economics couldn’t come at a worse time.

And the flap over Dubai Ports World’s takeover of a half dozen U.S. port facilities — when the entity will not be in charge of security — only adds xenophobic insult to trade-protectionist injury. Slapping one of our few Arab allies in the face at a time of war could have catastrophic consequences for growth and peace.

Low tax rates, stable monetary policies, and strategic alliances based on wealth creation, private property, dynamism, and trade represent the path to global prosperity. Strategic pro-growth partnerships may also help extinguish crises before they metastasize into war. Conversely, a competition between misguided members of both political parities to demagogue and xenophobe their way to higher poll numbers ultimately will produce policy outcomes that fail both growth and peace.

— Michael T. Darda is the chief economist and director of research for MKM Partners, an equity execution and research boutique located in Greenwich, Conn. He welcomes your comments here.

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