Courage campers. The future is golden (according to this guy):
April 18, 2000
Don't Worry, The Great Prosperity Is Still Coming
By Charles W. Kadlec, managing director of J. & W. Seligman & Co., a New York investment management firm, and author of "Dow 100,000: Fact or Fiction" (Prentice Hall, 1999).
Last week's dramatic sell-off in global stock markets is a painful reminder that stocks are risky. But don't be fooled. Historical forces continue to point toward a Great Prosperity that could carry the Dow Jones Industrial Average to 35000 by the end of the decade and 100000 by 2020.
Here are the reasons for optimism: Ronald Reagan's policies and the end of the Cold War made possible our current conditions of price stability, relatively low tax rates and freer trade. The aging of the baby boomers accentuates the forces for lower tax rates and stable prices. The technological revolution is breaking down the barriers to trade of time and distance. The spread of economic freedom is lifting millions out of poverty and increasing living standards world-wide. And competition is imposing market discipline on the public as well as the private sector. With all these historical developments pointing in a positive direction, the odds for future prosperity have seldom been as good as they are today.
The outlook for tax cuts looks good, notwithstanding Congress' recent stumbles on this issue. The federal surplus is now expected to exceed $3 trillion over the next 10 years. Once Social Security has been reformed, expect increased pressure from aging baby boomers to reduce today's high marginal tax rates, which nearly double the pretax cost of accumulating the assets the boomers will need to fund their retirements. State and local taxes are already declining; 1999 was the fifth year in a row in which they went down.
Going back to 1926 and excluding the wartime 1940s, annual economic growth has averaged 3.1%, while the S&P posted a total return of 11.7%. But during periods when the top personal income tax rate has been reduced, growth has averaged 3.7% and the Standard & Poor's 500 has posted an average annual total return of 16.0%.
The growth of world trade is likely to continue, despite this weekend's protests in Washington. The end of the Cold War increased our freedom to trade with more than a billion people. The technological revolution, too, is a powerful force behind free trade. With satellites overhead relaying everything from telephone calls to computer communications, and the Internet oblivious to national borders, the notion of protecting the U.S. economy from foreign competition is increasingly anachronistic, if not downright impossible. Periods of freer trade coincide with above-average annual growth of 4.2% and above-average stock-market returns of 14.9% a year.
Of course there are risks to our prosperity, including both military and trade wars. But prosperity and bull markets never die of old age; they are always killed by policy errors. Little wonder the market responded so quickly last week to the Federal Reserve's failure to maintain price stability. Early last Friday, the futures market was pointing to a positive opening until 8:30 a.m., when the March consumer price index was announced. Over the past 12 months, overall consumer prices were up 3.7%, and core inflation, which excludes energy and food prices, was up 2.4%. The futures market went into decline, and Wall Street slid all day.
Such a sell-off is symptomatic of the market's intolerance for the growing disconnect between Fed policy and the real economy. Just last month, Fed Chairman Alan Greenspan announced a radical new set of parameters for setting the course of monetary policy. Productivity gains and wealth creation were now a cause of imbalances that led to inflation. Moreover, under this new policy, stock market gains in excess of the growth of household income -- about 6% a year -- would be viewed as inflationary.
The Fed ought to focus on price stability, the restoration of which has been at the heart of the economy's remarkable performance and the stock market's record advance. In the period beginning in 1926 and excluding the 1940s, growth averaged 4.9% and the S&P 500 rose at a 17.2% average rate in years when inflation was in a band of plus or minus 2%.
The Fed must stop talking about all the potential imbalances over which it has no control and instead accept responsibility for maintaining the balance for the one thing over which it has direct control: the supply of dollars. When that supply is in line with demand, the overall price level is stable. Raising interest rates may drive the stock market lower and slow the economy. But it will not necessarily slow inflation. By contrast, an explicit price level target would lead the Fed to sell Treasury bills on the open market in order to slow the growth in the monetary base, bringing the inflationary supply of money back in line with demand.
The setbacks that produced the latest correction in the stock market are not prosperity killers. The market is simply responding to the Fed's policy mistakes. When wars end, societies typically find their way back to a stable price environment -- and the Cold War is no exception. The federal budget surplus, a product of the decrease in defense spending, has taken away one of the Fed's biggest excuses for inflation and high interest rates. Finally, the waning tolerance of the baby boomers for a monetary authority that threatens the value of their savings by attacking the rise in the stock market puts new political boundaries on this latest Federal Reserve error.
To get a sense of what is possible, I tracked the progress of the Dow Jones Industrial Average from 1926 through 1999, again excluding the 1940s. Over this entire period, the index advanced at an average annual rate of 6.5%. But in the 30 years among those 64 when two of the three key signposts -- taxes, inflation and trade policy -- were pointed in a positive direction, the index advanced an average of 11.1% a year. If this rate of growth were to prevail now, the Dow will cross 35000 near the end of the next decade, and reach 100000 around 2020. By then, this latest but far from last correction will be seen for what it is -- a minor bump on the road to the Great Prosperity.
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