Lawrence Kudlow
Sun, 31 Jan 1999, 11:28pm EST
U.S. Economy a Tale of Two Stock Indexes: Lawrence Kudlow
U.S. Economy a Tale of Two Stock Indexes: Lawrence Kudlow
(Lawrence Kudlow was chief economist at the Office of
Management & Budget during President Ronald Reagan's first term.
He's now chief economist at American Skandia Life Assurance Corp.
The opinions expressed here are his own and don't represent the
judgment of Bloomberg LP or Bloomberg News.)
New York, Jan. 28 (Bloomberg) -- Take a look at the
financial headlines covering fourth quarter corporate profits.
What thought jumps out at you? How about: profits from old
economy firms such as Dupont, Philip Morris, Nabisco, Mobil,
Conoco and Unocal are dropping. But profits from new economy
technology companies like AOL, Microsoft, Intel, Apple, and Yahoo
are rising way above expectations. Gales of creative destruction,
according to my favorite dead economist Joseph Schumpeter.
Technological breakthroughs are transforming the economy. The new
is replacing the old.
You can see it in the stock market, big time. The Nasdaq is
cannibalizing the Dow. Especially since the Internet Tax Freedom
Act passed Congress last October 8th, which ". . . . bars state
or local governments from imposing taxes that would subject
buyers and sellers of electronic commerce to taxation in multiple
states. Also protects against the imposition of new tax liability
for consumers and vendors involved in commercial transactions
over the Internet. . . . there should be no federal taxes on
Internet access or electronic commerce . . . keep electronic
commerce free from tariffs and discriminatory taxes."
Nasdaq Boom
Since passage of this Federal bill, the Nasdaq's 72%
increase is more than 3½ times the Dow's 20% rise. As a subset of
the 4,810 Nasdaq companies, the 20 publicly owned firms in The
Street.Com internet index are up an aggregate 278%. More gales of
creative destruction: the Nasdaq is creative, the Dow is
destruction. Actually, the Dow is not so much into destruction as
it is going through a transformation process with multiple
downsizings and restructurings.
Given a choice between a taxable market and a non-taxable
market, the consumer will choose the duty-free zone every time.
As supply-siders have long argued, taxes matter. The
Congressional tax ban on new cyberspace sales galvanized an
Internet shopping spree, according to John Simons' recent news
story in the Wall Street Journal, exactly the point I made two
weeks ago in an op-ed piece for that newspaper. Undoubtedly, this
shopping spree is spurring share prices for Internet sellers,
software makers, hardware producers and chip creators. It's all
of a piece.
Technology has become the backbone of our new economy. Old-
think economists may obsess over trade deficits from Asia and
Latin America, but new thinkers understand that information age
entrepreneurship is the real driver behind the perpetually
underrated U.S. economy. Zero inflation, a 20% capital gains tax
rate and low financing costs are maintaining the right homegrown
incentive structure.
Economic Power
Here's a factoid that underscores the economic power of
technology: over the past four years, computer-related output
increases have contributed nearly 60% to the rise in real GDP.
Actually, over the past year this contribution has jumped to 83%.
Rather than worry about a few small Pac-Rim countries whose
combined economic output is less than one-half of that produced
by the state of Michigan, it is technological innovation and
investment that is driving America's incredible job and wealth-
creating machine.
Meanwhile, computer price indexes in the national income
accounts are deflating at a nearly 30% annual rate over the past
four years. The hi-tech spillover effects on to old economy
smokestack companies are bringing down their prices as well. The
capital goods price index has fallen nearly 5% over the past
year. This illustrates another Schumpeterian maxim: periods of
rapid technological advance generate more output, with better
quality, at lower prices.
Spending Spree
While technology investment is driving the supply side of
the economy, strong consumer spending continues to bolster the
demand side. Say's Law of Markets reminds us that we produce in
order to consume. In today's free-market economy we are doing
both. In recent years department and chain store sales have
registered annual yearly gains of nearly 6%, while prices have
deflated at a 5% rate. So, in deflation-adjusted terms,
real, or unit sales are rising at a hefty 11% pace.
Retro-thinking monetarists keep grousing that strong
consumption is being driven by 10% to 12% growth of broad money
aggregates like M2 or M3. This misses the new economy point
entirely. Rather than a liquidity bubble, steady consumer
spending is being driven by the income earned from strong
computer-linked investment and production. Money supply growth is
a function of strong domestic (and international) money demand,
as individuals and business firms seek to put money to work in
our 20% investment rate-of-return economy.
Of course the new technology-driven economy is constantly
cutting costs and raising productivity. Non-financial output-per-
hour -- Alan Greenspan's favorite productivity measure -- has
been trending around 3% growth for years. Manufacturing
productivity is even stronger. This is why Mr. Greenspan told the
Senate Budget Committee today that ". . . the interrelationship
between tight labor markets on the one hand, wage increases and
price increases (on the other) is clearly a far more complex
process than is captured by the more simplistic views of a model
based on NAIRU (non-accelerating inflationary rate of
unemployment)."
'Superhuman'
Translating from Greenspanspeak, the Phillips curve is dead.
There is no trade-off between low unemployment and high
inflation. There is no reason for the Fed to tighten just because
people are working and prospering. In fact, slumping gold and
commodity index prices point to a global need for more dollar
liquidity and a lower Fed funds rate. Hopefully the estimable Fed
chairman will come around to this view before long.
So, the superhuman strength of the Nasdaq stock index has
become a metaphor for our new paradigm information economy. As
the Nasdaq pulls away from the old economy Dow, it is signaling
more growth, more efficiency, more profitability, more economic
transformation and more demand for money.
In tandem with soft precious metals and raw materials,
including oil, the rising Nasdaq itself is a signal of the need
for a more accommodative Fed policy. Connecting the dots from a
rising Nasdaq to a lower Fed funds rate may seem like a reach,
but the world is changing rapidly. Driven by technology, we are
in a deflationary boom. Monetary policy makers please take note.
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