Larry Kudlow

Paul Krugman is pessimistic about the economy -- which is not necessarily breaking news. But it never hurts to check in with one of the more bleak economic prognosticators of our day. What’s Krugman worrying about now?

Krugman points to the fact that interest rates on long-term bonds have fallen below rates on short-term paper as evidence that we’re headed for economic trouble. This circumstance is otherwise known as an inverted Treasury yield curve, and I actually agree with Krugman that it’s more proof the Federal Reserve is too tight.

Indeed, the yield curve is predicting continued economic softness, as is the current decline in the exchange rate of the U.S. dollar. But the central bank’s benchmark interest rate of 5.25 percent is simply too high. Fed chair Ben Bernanke would be justified to lower it to 4.75 percent, or even 4.5 percent.

That said, I disagree with Krugman’s conclusions about the record-breaking stock market. The New York Times columnist believes stocks are "a notoriously bad indicator of the economy’s direction," and he cites Nobelist Paul Samuelson who once quipped that the stock market had predicted nine out of the last five recessions.

As I’ve discussed on CNBC’s Kudlow & Co., the strong, across-the-board, five-month rally in stocks cannot possibly be predicting a recession. While the stock market can sometimes emit false positives on recessions, rarely does it give off false negatives. In fact, I think it is predicting a "Goldilocks" soft-landing for the economy.

A glaring omission from Krugman’s analysis is the staggering rise in corporate profits. These are the tax-return profits recorded for the IRS, and rest assured that no CFO overestimates them. Corporate pre-tax profits are up a remarkable 31 percent through the third quarter -- 25 percent after-tax. Profits are the mother’s milk of business and the economy, and these days we’re talking a serious amount of milk.

A question for Mr. Krugman: When in the history of humankind have we had a recession when business profits are rising by 30 percent?

Profitable U.S. businesses clearly have the resources to grow their operations and continue hiring new workers. This, in turn, is the biggest factor sustaining the historically low 4.4 percent unemployment rate, as well as the strong gains in jobs and consumer incomes.


Larry Kudlow

Lawrence Kudlow is host of CNBC’s “The Kudlow Report,” which airs nightly from 7 p.m. to 8 p.m.


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