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Jewish World Review Feb. 26, 2001/ 3 Adar 5761

Lawrence Kudlow

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Consumer Reports

Liquidity shortage -- BAD CPI and PPI reports for the month of January have sent a stagflationary shiver through the financial markets. I can buy the stag, but not the flation.

The stagnant economy is best illustrated by the continued drop of industrial production, which has fallen four consecutive months. Production is the single best coincident economic indicator. Two more monthly declines might well spell recession. Or, to use Vice President Cheney's phrase, "the front-end of recession."

Lower tax-rates to put more cash in consumer pockets and improve rewards for investment spirits and producer incentives will solve the stag problem. The more I think about the role of tax policy right now, the more I believe that a return to our 4% growth potential will not occur until a good tax-cut bill is signed.

As far as the inflation threat, every commodity price on the planet is falling. Including the mother of all inflation indicators, gold, which has dropped into the $250s, a 5¼% decline year-to-date.

So it would be a great mistake if the Federal Reserve holds back on its easing strategy just because of flukey one-month energy-driven PPI and CPI reports. If the Fed looked forward at the implied forecasts of market price indicators, instead of backward at flawed statistical reports, it would see declining future inflation and recognize the need to inject considerably more liquidity into the sinking economy.

Take a look at the commodity charts. Gold, silver, platinum, copper, cotton, lumber, steel, all down. Crude oil, down. Natural gas, down. New York unleaded gas and home heating oil, down. CRB futures, down. Spot CRB, down.

All this shows deflation, not inflation, in the air.

Significantly, gold and commodity prices are declining even while money supply growth is recovering. Monetarists like Bill Poole of the St. Louis Fed are actually worried about over-exuberant money growth. They shouldn't be.

MZM (money of zero maturity, really the old M1 plus institutional money funds) has spurted to 15.2% annualized growth over the past three months, while the broader money stock M2 has increased by 10%.

These measures are influenced by Fed policy, but they are mostly demand-driven by private sector transaction and investment preferences.

Lately, the biggest push to these money aggregates has come from huge mortgage refinancing activities, as households rebalance and re-liquefy their financial statements in the wake of lower interest rates. Also, turbulent stock markets may be inducing people to hold more cash.

The monetary base, however, which is the true supply of money directly controlled by the Fed through open market purchases of Treasury securities, is growing more slowly than transaction demand money. Base growth over the past three months has registered an 8.7% rate of gain, less than MZM and M2.

Therefore, there is no excess money problem that would foreshadow rising future inflation. That is why gold, commodities and interest rates are falling.

Greenspan & Co. are moving in the right direction by lowering the fed funds policy rate and expanding its creation of bank reserves, but the demand (MZM and M2) for high-powered cash (monetary base, or Federal Reserve credit) is rising faster than the supply.

Another way to see the ongoing liquidity shortage is the shape of the Treasury yield curve. As economists David Gitlitz and Marc Miles have recently pointed out, the short end of the curve is still inverted. Three-month Treasury bills yield more than two-year Treasury notes. And, as Mr. Gitlitz has pointed out, the fed funds rate still exceeds ten and thirty-year bond rates.

Commodity and financial market prices are smarter than government inflation indexes. When money supply data confirm market price indicators, the case is even stronger. There's still a liquidity shortage.

Mr. Greenspan in his most recent Senate hearing on monetary policy never spoke about inflation-sensitive market price indicators or money supply measures. Too bad. They're sending him an important message: more high-powered cash and a lower fed funds rate are necessary. The sooner, the better.

JWR contributor Lawrence Kudlow is chief economist for CNBC. He is the author of American Abundance: The New Economic & Moral Prosperity. Stephen Moore is president of the Club for Growth in Washington, DC. Send your comments about his column by clicking here.


02/15/01: Grow the Bush tax cut
02/08/01: The Breakfast Club
02/01/01: Shifting Political Winds
01/27/01: Inflation tax-cut
01/25/01: The Philadelphia Story
01/17/01: New Bull?
12/19/00: Help is on the way
12/04/00: Slumbering spirits
09/19/00: Euroland Tax Revolt is Good for the Europe
08/24/00: Tax Cut Issue in Campaign
07/31/00: Mr.G., you’re gaining on it
07/26/00: Investor Class Rising
07/17/00: The rising tide of national prosperity is lifting all boats
07/11/00: On Soft landings
06/29/00: Is the sky falling?
06/21/00: Internet-more-important-than-Fed update
06/14/00: The judicial hacker
05/16/00: Front-View Windshield
05/09/00: Don't Overreact
05/05/00: Give it Back
05/01/00: Wealth and Capital
04/18/00: Growth, Freedom and the New Investor Class--Stay the course
04/13/00: Correct Value
03/28/00: Governments roil the Markets
03/28/00: Fed should keep its powder dry
03/14/00: Reduce Debt, Derail Economy
02/17/00: Unsettled
02/10/00: Bush's Footprints
01/25/00: To preserve its standing as the world's number one economic power
01/06/00: It's not the '70s
12/28/99: They missed it
12/23/99: Bonditos
12/20/99: Dracula's Curve
12/16/99: When Alan Greenspan sneezes, Wall Street economists catch cold
12/10/99: Y2K-Related Cash
11/23/99: Y2K Money: Inflationary or Not?
11/16/99: Investor Retaliation
11/05/99: Rosy Lives
10/29/99: Drain Reserves
10/22/99: Supply-Side Is Mainstream
10/14/99: Y2K will likely bring more prosperity
10/07/99: Clinton's tax-cut veto
10/01/99: What's really bugging the stock market?
09/23/99: Growth Trade
09/09/99: Bad Dollar Logic
09/09/99: Buttered bread
08/31/99: Bull Market Alive and Well
08/26/99: Let Prices Rule
08/19/99: Blame OPEC, Not Growth

©1999, Lawrence Kudlow