Jewish World Review Jan. 06, 2000
http://www.jewishworldreview.com -- IT'S A "LIQUIDITY-DRIVEN" stock market, say the investment guru bears on Wall Street. Rising share prices are the result of exorbitant money supply growth. It's a huge bubble.
So, as this pessimistic argument goes, the Fed will keep tightening all through year 2000. And when they do, get ready for the big one, a 30% or worse sell-off.
Don't believe it. This 1970s-style monetarist view has been dead wrong for years. Instead, inflation-less growth and technology-driven productivity, profit and investment returns have been propelling stock markets higher, not excessive money creation.
What's more, if money flows were excessive, and if inflation were just around the bend, then stock indexes would be falling, not rising. The market knows full well that inflationary money would drive the unindexed capital gains tax through the roof, as happened during the 1970s. This punitive tax on market transactions and wealth-creation would stop the bull dead in its tracks.
Also, if money growth were excessive, then gold prices would be soaring and the King Dollar index plummeting. But that too has not happened. This is because rising dollar demand (in global financial markets) and the increased availability of goods have absorbed the growing dollar supply.
Monetarists have failed to recognize the upturn in dollar demand that has occurred in recent years. Steady disinflation and surging productivity in the Internet economy have generated more money chasing even more goods. The result: price stability.
During the tax and spend stagflationary 1970s, there was too much money chasing too few goods. This was truly inflationary, as foreshadowed by skyrocketing gold and a sinking dollar.
But economic conditions today are radically different than the 1970s. In fact, even in monetarist terms, today's story looks good. Over the past five years, the key Friedmanite money supply measure M2 has grown at a 6% annual rate, virtually the same as the 6% yearly growth of nominal GDP.
Is 6% too much? No. Real growth has averaged over 4% per year, while inflation has been less than 2% annually. A very good mix. That's what the stock market bull has been telling us.
Also, after temporarily bulging in 1998 -- largely from a surge in the crisis-laden foreign demand for dollars -- money growth has slowed markedly in 1999. Measured over twelve month periods, M2 has eased to less than 6 1/2% growth from 8 1/2%, while the more transaction-oriented MZM (money with zero maturity, which is M2 minus small denomination time deposits, plus institutional money market funds) has declined to 9 1/2% growth from nearly 15%.
Measured on a higher frequency six-month growth basis, the deceleration rate (change in the rate of change) is 52% for MZM and 40% for M2. Surely those of the monetarist persuasion will agree that money growth, or liquidity growth, is going down, not up. And on that basis, surely the Fed needn't keep tightening credit policy.
I'm not sure what all this means, since money supply growth alone has been a poor predictor of inflation or economic growth over the past two decades.
However, updated statistical correlation analysis does hint that slower money growth could be signaling a slower economy next year. But the link between money and inflation remains statistically insignificant.
Perhaps the "liquidity-driven" crowd is looking at the yearend rise of bank reserves and the monetary base. If so, here too they are barking up the wrong tree.
The Fed is properly exercising the use of an elastic currency to ward off potential Y2K computer-bug emergencies that might unleash a tidal wave of currency demands. They have injected roughly $70 billion in term repos, with another $450 billion in repo options as additional insurance.
But all this extra cash will be pulled out of the banking system in January and early February when the repo loans expire. It's an automatic process with fixed termination dates. There's no discretion. There will be no permanent effects on money growth or spending.
Bottom line message to monetarist-minded investment strategists: this is not the 1970s. We should all live in the now, not the then. The then was bad, but the now still looks good.
Inevitably, stock market corrections come and go. Of course there will be more of this. But this is a healthy self-correcting process. A plus, not a minus, for long-term investing success.
Happy New Year. May your outlook be optimistic, your tax-rates lower, and your portfolio higher.
Most important in the new millennium, keep the faith. Faith sustains us.
Faith is the
JWR contributor Lawrence Kudlow is chief economist for Schroder & Co. Inc and CNBC. He is the author of American Abundance: The New Economic & Moral Prosperity. Send your comments about his column by clicking here.
12/28/99: They missed it