Kudlow: Fed Threatens Prosperity
By Lawrence Kudlow
CNBC.com Chief Economist
If Robert Novak's syndicated column yesterday about the Fed is even partly correct -- and I believe it is -- then
financial markets could be in for a bumpier near-term ride than most folks think. And certainly bumpier than our
inflation-less prosperity deserves.
The estimable Mr. Novak, who is surely the most influential conservative journalist around, and quite possibly the
number one media commentator of his generation, believes that Alan Greenspan is being pressured by President
Clinton's Fed appointees into a new tightening cycle that will be much more aggressive than the Chairman wants.
Greenspan reportedly preferred only a 25-basis-point rise in the overnight federal funds rate. However, the
Clintonite Gang of Three -- Laurence Meyer, Roger Ferguson and Edward Gramlich -- insisted on a
50-basis-point hike. Greenspan apparently decided to switch rather than fight. Even worse, the Fed
announcement left the door open for another 50-basis-point credit tightening in June. And perhaps a third
50-basis-point move in August.
In the context of a rising dollar and a falling gold price, alongside surprisingly benign April inflation reports, there
can be no doubt now that Fed policy is aimed directly at curbing economic growth. Buggy whips in hand, with
bugles blaring, the Fed austerity brigade is armed with an old-economy Phillips curve designed to slay
non-existent inflation by depressing the new Internet economy.
Ride on, fellas. Right out of a 1950s smokestack playbook. Too many people working. Too many people getting
raises. Too much investment. Too much productivity. Too much -- prosperity.
There were even a couple days leading up to the last Fed meeting when the stock market appeared to be
recovering. Of course, the market was signaling strong approval of George Bush's private investment account
reform of Social Security. Good thing the Fed stopped that before it got out of hand. Much too good an idea.
Nearly 15 years ago a similar Fed story occurred, but in reverse.
Shortly after President Reagan appointed commodity price watchers Manley Johnson and Wayne Angell, they
banded together with earlier Reagan appointees (Preston Martin and Martha Seger) to pressure Paul Volcker
into an easier money policy.
Volcker nearly resigned, but then, like Greenspan, he went along. But then easier money was the correct course.
Now, tightening overkill is a terrible idea. Is it possible that Mr. Greenspan is considering resignation?
As a footnote to the saga, Bob Novak pointed out that the "Super-hawks" want to move the fed funds rate
upward in line with the growth in nominal GDP (total spending in the economy, which grew at an 8-percent rate in
Q4, and 7.5 percent over the past year). This, by the way, is a view held by a number of Reserve Bank
presidents, as well as the Clintonite Board members.
Consequently, Laurence Meyer & Co. may be preparing for a 7.5-percent or even 8-percent fed funds rate. So
here's a warning: This harsh tightening mode is not yet discounted by financial markets. Not stocks or bonds.
Both the fed funds and eurodollar futures markets are suggesting no more than 75 additional basis points of
tightening, but certainly not 100 or 125 basis points.
Trouble is, by the time the Fed gets to an 8-percent funds rate, money and GDP growth will already be slowing.
That's why looking through the rear-view mirror is such a bad idea. Forward-looking prices, such as gold and the
dollar exchange rate, are much better inflation indicators.
The Meyer plan would be a very risky scheme. If this worst-case scenario comes to pass, then real economic
growth in the second half of this year could drop below 3 percent. Even worse, next year's growth could hover
around 1.5 percent. This is a long stone's throw from the 6-percent-plus growth of the past three quarters. And
whenever we start down this slippery slope, recession can never be ruled out. Stocks won't like this one bit.
Mind you, this is still not my best-guess forecast. There is no inflation, and the economy appears to be cooling but
not collapsing. Therefore, it is always possible that the monetary professors will seek Higher Guidance and come
to believe in the benefits of prosperity. The economic numbers in the weeks ahead will be very important.
However, if the Laurence Meyer Phillips curve Gang of Three remains on a tear, then investors had better tighten
their seatbelts. Cash is starting to look better and better.
Of course, an optimist like myself always looks for the cute little pony among all the manure. Where's the pony?
The presidential election is less than six months away. Tax cuts and two unfilled Fed Board seats will be back in
play.
It may well turn out that the Greenspan Fed is an equal-opportunity presidential unemployer. Bush the Elder has
never stopped blaming Greenspan for his 1992 re-election defeat, though in truth Fed policy that year was much
less important than his broken no-new-tax pledge.
As for campaign 2000, Al Gore's "it's the prosperity, stupid" mantra may go down in flames from Fed overkill.
Oh well, every bear market has a silver lining.
cnbc.com. |
