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Alan Greenspan told the Senate that the war was the problem. Growth will rebound,
he said, when the Iraq conflict is over; therefore we don't need
the president's stimulus package.
If you agreed with Greenspan, you probably thought the stock market
would take off like a rocket once Saddam was history. Think again.
Don't forget that the economy was in the tank for more than two years before Iraq was a gleam in the president's eye. No, the war isn't the problem. The Fed is. Physician Greenspan, heal thyself. Oh sure, an impending war is a deterrent to capital spending. But don't look for a strong rebound when the war ends. The economy still suffers from what caused the recession in the first place: tight credit and excruciatingly slow revenue growth for American companies. No surprise we have falling stock prices. Scott Rasmussen's daily opinion polls (http://www.scottpolls.com) show consumer and investor confidence at their lowest levels since October. Investors prefer real estate to equities by 66% to 21%. When the war scare abates, we will still have the Greenspan problem. Despite low interest rates, tight credit has been a problem since the fall of 2000 when the Fed and controller tightened the screws on lending to protect the banks from the weakening telecom, cable and technology industries. Unfortunately, that move squeezed the wrong guys, because it is easier to call loans from a small company, which has good inventory and receivables, than from a cable company, whose assets are buried deep in the ground. Thus the brunt of the recession fell on midsize private manufacturers and distributors. Doubt me? Here are the numbers: Bank commercial and industrial loans today are 9% lower than two years ago. Over this period the S&P 500 has fallen 38%. Nominal GDP is limping along at about 3% per year, less than the 4% productivity growth we enjoyed last year. Which means there is downward pressure on prices. In this sluggish environment, old economy companies like General Motors (nyse: GM - news - people ) cut prices to keep factories running and cash flowing. That creates bargains for consumers, but it's lousy for corporate earnings and for equities. When there are fewer bargains for consumers, there will be more corporate capital spending and a stronger stock market. It is up to the Fed to provide sufficient liquidity to keep durable goods prices from falling. This has little to do with Saddam; it has everything to do with Greenspan. Lack of credit, falling prices and war risk have combined to push stock prices 21% below their intrinsic values, according to our estimates at Rutledge Research. How quickly the stock market recovers after Iraq is in Greenspan's hands, not Saddam's.
If Congress passes President George W. Bush's dividend tax cut,
the case for monetary expansion is even stronger. The tax cut will
increase the after-tax return on dividend-paying stocks relative
to all other assets, including tangible assets like land, commodities
and used cars. Easier credit combined with dividend tax reform could
create the potential for an explosive rally in stocks. Over to you,
Chairman Greenspan.
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