WHAT'S MORE IMPORTANT THAN THE FED?
By Lawrence Kudlow, chief economist at Schroder & Co. and at CNBC.com, and author of "American Abundance: The New Economic and Moral Prosperity" (Forbes, 1998).
Now that the Federal Open Markets Committee has raised interest rates for what we hope will be the last time this year, it's time to stop obsessing about Fed policy and turn to what's really important in today's economy. Thanks to a combination of positive developments, including the far-reaching impact of the Internet, the long bull market cycle of prosperity is alive and well, regardless of what the Fed does.
Consider all the good news: Treasury bond rates have peaked. Consumer price inflation is running at only 1.7% annually year-to-date, excluding the temporary oil shock. This is considerably less than last year's 2.4% pace. Technology investment is growing at a phenomenal 40% annual pace, expanding the economy's long-run potential. Using this technology, worker productivity is increasing 5% a year in the factory sector, 4.5% in nonfinancial corporate America and 3.5% for overall nonfarm business--faster on the whole than the 3.5% to 4% rise in wages and salaries.
Business profits through midyear have risen 16.5% from 1998, including a 44% gain for computers and software, 41% in durable goods, 38% in telecommunications, 30% for retailers, 15% for financial services and 12% for capital goods and health care. This explains yearly stock market gains of 31% for the Dow Jones Industrial Average, 26% for the Standard & Poor's 500 and 57% for the Nasdaq.
Industrial production has risen 3.6% in the past year, while factories' capacity to produce is growing at a 4.1% rate. So the supply side of the economy is expanding rapidly, leaving plenty of room for future growth without straining resources.
Why all the good news? Because the Internet is more important than the Fed. Easily accessible, low-cost information and increased competition, the hallmarks of Internet economics, will contribute substantially more growth with significantly lower prices. Over the past year computer production has increased 41.5%, while computer prices have fallen 30%. Think of it as deflationary growth, a classic consequence of long-wave technology cycles.
Record-breaking venture capital investment is nurturing Internet innovation and high technology in general. PricewaterhouseCoopers reports that venture-backed investments in this year's second quarter hit a record $7.7 billion, a 104% rise over last year. Internet-related company financing quadrupled, to $3.8 billion. The number of companies receiving funds more than doubled, to 412 from 174. Investments in this year's second quarter exceeded the total for all of 1998.
Venture capital is the lifeblood of the new economy. New ventures require seed capital in order to be commercialized and then brought to the mass market. These record venture-capital flows, undoubtedly bolstered by the recent decline in the federal tax rate on capital gains, point toward even faster technological innovation in the next century.
Now back to the Fed. Regrettably, Alan Greenspan & Co. continue to stray off the price rule. Instead, they have wandered into the historical back alley of Malthusian limits to growth and employment. This old-economy thinking, epitomized by the discredited Phillips curve trade-off between inflation and unemployment, reflects the tired wisdom of the economics establishment. Promoting the incongruous policy prescription of higher interest rates and paydowns of the federal debt, the Fed has even abandoned the original Keynesian first principle of growth.
Growth is the intellectual dividing line in American politics. Free market supply-siders embrace it; it makes orthodox economists nervous. Slumps born of austerity policies open the door for economic planners and bigger government influence. Prosperity from free-enterprise growth has no need for government targets and controls. The market itself is the most effective regulator of resources.
In monetary policy, market prices are the most efficient regulators of the supply and demand for money. With gold low and the dollar index high, it is clear that the volume of money provided by the Fed is just about right. There is no need to withdraw liquidity or attempt to fine-tune the economy's growth rate. Today's growth is real, not inflationary.
If the economic establishment continues to press austerity and pessimism, it will be confronted by a tidal wave of opposition from the shareholders, farmers, seniors, homeowners, Web site operators, venture capitalists, small-business men and others who make up the new investor class. These asset owners know that markets, not governments, create wealth. They will not permit new tax, monetary, trade and regulatory obstacles to impede free enterprise. They know that entrepreneurship spells opportunity.
Think of the Internet as an economic-freedom metaphor for our time. The Internet empowers ordinary people and disempowers government. The Internet creates wealth, expands growth, produces jobs and spreads prosperity. Standing behind the Net is the political power of well over 100 million investors and asset owners.
Because of this, I believe the future economy will outperform all expectations. The Dow Jones Industrial Average will reach 15000, then 30000, then 50000 and higher. Believe it or not, the Internet is more important than the Fed.