Why Clinton is irrelevant to the economy as he goes down:
August 6, 1998
The Economy Is Safe,
Even if Clinton Isn't
By LAWRENCE KUDLOW
Stocks have been taking a hammering these past couple of weeks, really
since Federal Reserve Chairman Alan Greenspan, in congressional
testimony, threatened higher interest rates and opposed using budget
surpluses for pro-growth tax cuts. It was a bad hair day for our favorite
central banker, and he has given the markets a real haircut.
Pessimistic media commentators have also jumped on the news that real
gross domestic product rose at a meager 1.4% annualized rate in the
second quarter to warn of a coming economic slowdown or even of a
recession. Analysts are in a foot race to lower earnings estimates. Everyone
is blaming Japan. Sophisticates are linking the market downturn to Monica
Lewinsky, Ken Starr and Bill Clinton. Choose your poison.
But are things really so bad? I don't think so. Let's take the political
argument first. Yes, of course, prospective grand jury testimony by Ms.
Lewinsky and assistant White House counsel Bruce Lindsey, as well as the
president himself, add a risk premium to the economic and financial
landscape, and the stock market has been pricing in this risk.
Yet even in the worst-case, impeachment-and-resignation scenario, it
remains that Mr. Greenspan, the author of zero inflation, will remain as Fed
chairman. Robert Rubin and his strong-dollar policy will probably also
continue at the Treasury Department, despite rumors that he is on his way
back to New York. And the dollar is getting stronger, not weaker.
Some fear that a President Gore would operate to the left of Mr. Clinton,
especially on environmental issues. However, the Republican Congress will
surely be re-elected, probably with larger majorities, so a big expansion of
costly government regulations is unlikely.
In fact, it could easily be argued that the GOP would do far better against a
rookie President Gore than against the persuasive and wily Mr. Clinton. In
this scenario, the prospect for payroll tax cuts to fund private retirement
accounts, income tax rate reduction, a capital gains tax of 15%, a lower
inheritance tax and accelerated business depreciation allowances might be
substantially improved. These actions would increase the present discounted
value of future profits, growth and stock market values.
In recent days some observers have warned that the Clinton crisis could
follow the pattern of the Nixon resignation, which was linked to the vicious
stock market downturn and deep recession of 1973-75. But this misses a
crucial point: President Nixon's economic policies were decidedly
antigrowth; indeed, he was arguably the worst president on economic issues
in the second half of the 20th century.
Let's not forget that Nixon unhinged the dollar from gold and authorized a
big money-supply expansion executed by his chosen Fed appointee, Arthur
Burns. This launched America's first double-digit inflation. Double-digit
interest rates soon followed. Both devastated the stock market and the
economy.
At the same time, other senior economic-policy makers, such as John
Connally, George Shultz and Herbert Stein, along with Nixon and Burns,
developed wage, price, interest, dividend, profit and energy controls that
ripped apart the nation's incentive structure and undermined the ability of
product and credit markets to allocate resources efficiently. To add insult to
injury, taxes also went up, as did federal spending on entitlement programs.
This Keynesian concoction so debilitated the economy that the country
never truly recovered until President Reagan's policies of sound money,
lower spending, tax cuts and deregulation took effect in the 1980s, a full
decade after Nixon's follies.
Thus it was bad economic policy, not Watergate, that dragged the nation
into recession. By contrast, today's healthy economy is the result of the
intellectual triumph of free-market economics and a rollback of government.
These in turn have contributed to the spread of information technology and
a vibrant culture of entrepreneurship.
Mr. Clinton has been a willing if occasionally reluctant participant in this
wealth-creating era. He deserves credit for accepting a sound dollar and
domestic price stability, and for advocating free trade. But he deserves no
credit for his oversized 1993 tax hike. It is no coincidence that the big rise in
stock market prices occurred after the November 1994 Republican
takeover of Congress. Since then the Dow has gained about 5000 points.
Also since November 1994, the budget has moved from deficit to surplus,
savings and investment incentives have been restored through a lower
capital-gains tax and expanded IRAs, and the growth of entitlements has
been restrained by the passage of welfare reform. Proposals for
European-style social insurance policies, especially nationalized health care,
are dead in the water. So are the higher tax rates necessary to finance them.
Each of these policy developments improved the general economic outlook,
which in turn pushed the stock market to higher levels.
The classic recipe for bear markets and recessions includes major increases
in inflation, large interest rate and tax hikes, and protectionist trade
restraints. None of these policies loom even remotely over the horizon.
Instead, the economy is virtually inflation-free and market interest rates have
been trending lower. Consumer spending and business investment is strong,
and the inventory correction that has temporarily slowed growth will actually
prolong the expansion. Outside of raw materials producers,
semiconductors, and energy, which have been hard hit by the Asian
downturn, corporate profits are actually rising by about 10%.
It may not be too Panglossian to expect that a bear market or recessionary
threat could mobilize election-minded Republicans to move on at least some
pro-growth tax cuts, especially self-financing capital gains cuts and
inheritance relief, and a widening of personal tax brackets. Tax bracket
creep, in which rising real income pushes workers into higher tax brackets,
poses a sizable threat to prosperity. In fact, taxes have eaten up 42.6% of
the rise in wage and salary income over the past year, twice the normal
burden.
Certainly our poll-watching president recognizes that the Monica chronicles
will take a much greater toll on him if the economy takes a turn for the
worse. So he may again put on his supply-side hat, as he did a year ago
when he signed a capital gains tax cut bill.
Even the recently dour Mr. Greenspan may change his tune and realize that
commodity deflation, not higher real wages, is the real risk. If he does, the
stock market correction may well serve as a wake-up call for tax cuts, an
accommodative flow of money to finance them, and a hard-as-a-rock
dollar. Which, incidentally, was exactly Mr. Reagan's pro-growth
prescription nearly two decades ago.
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