A super scenario

Larry Kudlow
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Posted: Jan 04, 2002 12:00 AM
In case you didn't see it over the New Year's weekend, Barron's published a provocative and counter-conventional article by L. Douglas Lee, titled "The Case for a 'Super-V.'" That's "V" as in the shape of our economic recovery trajectory. Having hit bottom already, the article's author thinks we're gonna rocket back up. Lee projects that first-quarter real economic growth could range between 4 percent and 6 percent, with December-to-December growth ranging between 5 percent and 7 percent. That's a big-bang forecast, and it puts conventional wisdom to shame. While I'm not familiar with Lee's analytical biases (Is he a Keynesian? A supply-sider?), his was a well-reasoned brief. And of course, I'm always a sucker for a truly optimistic economic outlook. In making his argument, Lee mentions "extraordinary" Fed easing that includes declining interest rates, an expanding money supply and a steepening Treasury curve. He also mentions last spring's tax cut, which will throw off $38 billion in stimulus, along with numerous congressional spending bills. Lee also sees the potential for an inventory reversal that will add substantially to near-term economic growth. Additionally, he believes that vibrant business-capital spending may arrive faster than consensus pessimists anticipate. (Recent reports on rising durable-goods purchases -- including the ISM manufacturing index -- back up his claims.) Lee mentioned two points that are worth expanding. First, the across-the-board Bush tax cut of last spring reduces marginal rates on personal incomes by an additional half a percentage point this year. It ain't huge, but it doesn't hurt, either. In particular, middle-income taxpayers will benefit from passing through the new 10 percent bracket for the first $12,000 of taxable income. Somewhere in this tax-cut mix there are improved work and investment incentives, however small and gradually implemented they may be. Remember -- for top earners, the marginal tax rate drops to 35 percent in 2006. On the same front, tax-free saving contributions for IRAs and 401(k)s rise significantly this year, and even more for those of us over 50 years old. This is a big -- and underrated -- investment incentive. In the 1997 tax-cut bill, super-saver accounts were also expanded, and combined with a reduced capital-gains tax rate this measure helped to spur the huge capital-investment that stimulated technology-related entrepreneurship and growth. The second point worth expanding is monetary. Lee writes that "the U.S. monetary aggregates are all showing faster growth," which reminds me of the fact that not one in a thousand economists considers the economic power of money-supply changes. All of us should. Here's why: The basic liquidity measure controlled by the Federal Reserve is the monetary base. The Fed adds money by expanding bank reserves and currency in circulation through the purchase of Treasury bills from designated Treasury dealers. Reversing the liquidity deflation of 2000, which was directly responsible for the recession in 2001, the central bank has expanded the monetary base in the past 12 months by $53 billion -- with most of the injections taking place after the Sept. 11 terrorist bombings. As a result of this liquidity expansion, the monetary base increased by roughly 9 percent in 2001. As this money circulates through the economy, it will generate a higher level of nominal spending (on consumption and investment). And this brings us back to Lee's 5 percent to 7 percent projected growth range for 2002. The 9 percent growth in the monetary base could conceivably produce an 8 percent increase rate in nominal GDP in the next 12 months. Figure in a 1.5 percent or 2 percent inflation rate, and the real economy could rise by more than 6 percent this year. Add to this the mild dose of tax incentives, and you have the possibility of a recovery growth rate that is way above the 3 percent consensus view for this year. Add to this the reversal of last year's energy-price shock -- and let's not forget the rising confidence factor related to President Bush's successful prosecution of the war on terror -- and another piece falls into place for the "Super-V" scenario. Washington's recent stimulus package may be dead, but a strong recovery outlook is not. It all makes sense to me. That is, this 50-plus senior citizen who will invest more in his super-saver accounts to create stock-market wealth just loves a really optimistic economic scenario.