Alan
Greenspan told the Senate this week the war's the thing. The growing prospect of a war with Iraq has damped business investment and made businesses reluctant to hire new workers; therefore the economy is weak. Growth will rebound when the Iraq conflict is over. It's too soon for Congress to consider the President's
stimulus package. Besides, tax cuts that increase deficits are
a bad idea anyway. We need fiscal discipline.
Apparently Alan has forgotten that the economy
has been stinking it up for more than two years. As much as we
would like to blame it all on Saddam Hussein, it is actually the
Fed that's causing the problem. Physician heal thyself.
I'm not denying that an impending war is a deterrent to major spending decisions. No rational business manager would commit to an expensive investment project on the eve of war. The option of waiting a few weeks to see what happens-finance professors call it a real option-is
just too valuable to give up.
And it's not just business managers. Scott Rasmussen's (www.scottpolls.com) daily opinion polls-more current than the Conference Board- show
both consumer and investor confidence at their lowest levels since
October, 1981 as well. This weeks data show investors prefer real
estate to equities by a 66% to 21% margin, up from 60% to 32% before
the war drums started.
When the war drums stop everyone can exhale and people can make economic decisions again. My point is simply that we should not expect a rebound to strong growth because there was no bound in the first place. The economy still suffers from the problem that caused the recession in the first place, tight credit and slow revenue growth.
Tight credit has been a problem since the fall
of 2000 when the Fed and Controller tightened the screws on bank
lending to protect the banks from losing money in the weakening
telecom, cable and technology industries. Unfortunately, it is
easier to squeeze a small manufacturer or service company, which
has good inventory and receivables, than a cable company, which
has buried the money under the street in front of your house. That's
why the brunt of the recession fell on mid-size private companies,
where bank loans today have fallen $135 billion (9%) over the past
two years.
The Fed has the ability to reverse this by adding
bank reserves-they have not done so to date. The second problem is low revenue growth for most companies, which the press has dubbed weak pricing power. Revenue for the average company can't grow faster than nominal GDP, which is streaking currently along at about 3% per year, less than productivity growth. Most of this growth is concentrated in service companies-revenue for goods producers and distributors is flat or falling. That's why the auto companies have to discount prices and offer zero interest loans to sell cars. And that's
why so many companies cite disappointing revenue growth as the
reason for weak earnings.
The Fed can and should increase nominal GDP growth to a number higher than productivity growth so goods prices stop falling. Only then will we see a rebound in capital spending. It would be even better if this growth increase could coincide with the successful conclusion of the war and the signing of the dividend tax cut.
Lack of credit, falling prices, and war risk
have combined to keep stock prices far below intrinsic values,
and have pushed Treasury yields too low. Markets may sell off again
in the coming weeks in the final run-up to war. It will be up to
the Fed how rapidly the economy and the stock market rebound after
that. |
