It's not the accounting fraud, the corporate corruption, Martha
Stewart, left-wing demagoguery about tax cuts for the rich, the budget
deficit or the war on terror.
It's balance-sheet deflation and the corporate credit crunch.
These are two faces of the same ugly coin. And if they're not dealt with
soon, we may be staring at the weakest economic recovery in 50 years.
Unfortunately, our money men in Washington don't seem to understand this
Major corporations throughout the land are trying desperately to
rid themselves of excessive debt-burdens accumulated during the last
economic boom. But risk-averse investors don't want to buy corporate bonds
to cure that debt. And high real interest rates are putting the squeeze on
profits and operations.
With real interest rates abnormally high, companies are having
to spend virtually every new dime of income on interest expense to service
their unwieldy debt. This leaves very little money to spend on new capital
investment, additional production or new job hires.
This economy isn't double-dipping into another recession, but it
is growing too slowly to solve the corporate credit-crunch barrier to a
full-fledged business recovery. Inflation-adjusted domestic final sales, a
good measure of how goods are moving in the marketplace, has grown only 3
percent annually over the past three quarters. This pace is way too slow to
bail out debt-strapped companies.
There's nothing lawmakers on Capitol Hill can do to rid firms of
their burdensome debt (although they can help out this economy in several
ways). But there's plenty the Federal Reserve can do to lower the onerous
burden of unusually high real interest rates.
The classic solution to a deflationary problem such as this is
to pour new cash into the economy. Immediately following the terrorist
attacks on Sept. 11, the Fed seemed to be appropriately stepping up its
creation of new money. Not surprisingly, economic recovery took hold nicely
in last year's fourth quarter and this year's first.
Lately, however, the Fed has lapsed into its historic obsession
with short-term interest rates. Instead of lowering the fed funds rate this
week -- a move that would have allowed it to buy Treasury bills and inject
more cash into the financial system -- the Fed decided to hold the rate at
1.75 percent. The rate has been at this "low" level since November, but the
Fed mistakenly believes that a low and steady fed funds rate infers an easy
cash policy. Paradoxically, this rate-targeting led to a significant decline
in the Fed's cash-creating operations right when businesses needed the money
Cash demands are not only skyrocketing in the United States, but
also in Latin America. The collapse of southern-cone economies such as
Brazil, Argentina, Uruguay and Paraguay, along with the already ailing
economies of Venezuela, Colombia and Bolivia, has created an even greater
demand for dollars throughout the hemisphere. Yet a Fed that can't even
provide a money pipeline to its businesses at home is apparently oblivious
to growing dollar demands below the equator.
It is rumored that the White House is finally considering a
much-needed reform of the tax treatment of dividends, a positive move that
would lessen the incentive for company debt and improve the incentive for
individual stock purchases. Stock broker Charles Schwab proposed this, and
President Bush indicated enthusiastic support.
Undoubtedly the Tom Daschle Democrats will attack this as a tax
cut for the rich. But surely the president and congressional Republicans up
for re-election will see the benefits of reaching out to the investor class.
The president's men may also be looking at an increase in
capital-loss deductions, a tax-free turnover of stocks and perhaps even a
tax-free status for business start-ups. All of these measures would improve
the outlook for the economy and the stock market. So would a thorough
corporate-tax overhaul. U.S. businesses currently rank 24th worst among
industrial countries in this department. We can do better.
But our central bank must get in on the corporate-stimulus act.
The Fed must relinquish its interest-rate targeting, let the fed funds rate
go where it goes, buy back Treasury bills and get a substantial amount of
fresh money moving toward cash-strapped businesses in need of a boost.
Higher prices for gold and industrial commodities will tell the government
bank if they are succeeding.
This simple monetary reform will solve the corporate credit
crunch and will soon end deflationary price pressures that still ripple
through the economy. Along with pro-growth tax reforms, a new monetary
approach will generate sufficiently rapid economic expansion to finance a
strong business upturn at home, and pay for a victorious conduct of the war
against terrorism abroad.