Tuesday, April 19, 2005
Today the better answer, one I've been thinking for awhile, comes from Brian Wesbury in this morning's WSJ (link for subscribers only): Market hate uncertainty. And goodness knows there's been a lot coming from Washington.
It could be even worse than moribund, given developments in Congress that Ben Lieberman highlighted yesterday.
The 2003 tax cut, which reduced tax rates on capital to the lowest level in decades, continues to fuel economic activity as evidenced by the surge in business investment, profit growth and dividends. The real fed-funds rate remains near zero, even after seven "measured" Fed rate hikes. Corporate and household balance sheets are in good shape, and entrepreneurial activity is vibrant.
While retail sales were weaker than expected in March, they are a volatile data series that has disappointed on at least five different monthly occasions in the past two years. Removing the month-to-month volatility, non-auto retail sales are up 7.5% at an annual rate in the past six months -- a very strong showing.
Markets are rarely surprised by shifting economic tides on such short notice. Policy shifts, on the other hand, are a different story. For example, following the election in 2004, markets got a nice boost as the odds of pro-growth fiscal policy increased dramatically. But this boost is evaporating as it now appears that fiscal policy is adrift. While the House of Representatives voted to eliminate the estate tax last week, it offset this potential positive in the previous week by voting to slap a tariff of 27.5% on all Chinese imports. And in the Senate, a train wreck is looming.
Democrats have filibustered many of the president's judicial nominees and are now using other procedural methods to block his picks to head the FDA and EPA. Republicans are frustrated by this, and are contemplating a "nuclear option." The Democrats have threatened to retaliate. No matter what your view is of these developments, gridlock could easily worsen. And while gridlock is typically a good thing in Washington, there is potential that partisan wrangling could hold up progress on dealing with long-term issues. Momentum toward personal accounts in Social Security has seemingly stalled, as has any vote on the extension of the 2003 tax cuts. Energy policy, even with $50-oil and $2.50-gasoline, remains moribund.
In short, the problem is Congress and economic policy. There has been significant concern that, while fiscal policy probably needs to be more restrictive, government is unlikely to do anything in that direction. The Bush Administration has been blessed little help: Please tell me what is Bush economic policy right now. I can no longer really say. The loss of momentum on tax cuts that Wesbury cites is the direct result of the singular focus on saving the Social Security plan, which as Ed Crane pointed out is wrongheaded to begin with.
Intensified fighting over the nuclear option and filibuster rules only compound the problem. As long as Senate Republicans continue to dally over forcing a vote, markets will continue to be uncertain whether the tax and regulatory plans Republicans proposed in the 2004 election will come to fruition. The response to that uncertainty is to slow investment and big-ticket purchases.
The current environment is best compared to the early '80s, not the mid-'60s or '70s. In the early '80s, fears such as those recently expressed by Mr. Volcker were widespread. But the consistent move by the U.S. toward global freedom and pro-growth policies at home eventually won the day. Interestingly, by fighting inflation, Mr. Volcker was part of the solution to stagflation in the early '80s.
And if we are going to move forward now, the Fed has to get more serious about fighting inflation, and the Bush Administration has to learn that economic policy is about more than private accounts. It could get serious right now by naming an inflation hawk as the new Fed chair to replace Greenspan at the end of the year. Getting that nomination confirmed would reduce market uncertainty, buoy stock markets, and might even firm the dollar.