Jewish World Review Nov. 7, 2002 / 2 Kislev, 5763
David R. Kotok
http://www.NewsAndOpinion.com | Our four pillars of stimulus won the election and the Fed's vote, too.
1. Monetary policy. Clearly the Fed continues to follow the policy outlined in their important June paper. They will err on the side of inflation in order to lessen the risk of deflation. The 1/2 point cut is an affirmation; we were surprised since we expected a 1/4. Fed Funds are destined to stay under 2% for the rest of this year and the better part of next year. We do not expect the Fed to begin to reverse its easing policy until 3 to 6 months AFTER the Unemployment Rate has peaked; that may not be until next summer.
2. Fiscal policy. The election outcome means an easier time for President Bush to get the spending he desires. We expect the deficit to top 250 billion. That is before tax cuts which may be coming in larger measure and sooner than they would have if the Democrats had maintained control of the Senate.
3. Tax policy. A series of tax cuts are already in the law. These will be expanded. Changes in IRAs and 401Ks are coming. So are other investment oriented policy improvements. Taxpayers are big winners of this election.
4. Structural stimulus. We have argued that a change in U.S. policy occurred when our government reversed itself and started to extend credit through international agencies. Witness the 30 billion to Brazil. We expect more of this activity. We believe an extension of credit in this form is stimulative just like any other extension of credit to an otherwise failing borrower. We are guessing that Argentina will receive rollover financing from the International Monetary Fund. Such a credit decision can only occur if the United States is in concurrence.
5. There is now a 5th wheel in the works. Texas policy influences have a history of willing benign neglect of the value of the dollar. David Hale has written extensively about this historical phenomenon. The results of the election will make it easier for the Bush Administration to allow the dollar to drift lower. We don't expect this to be a stated policy. It will come in the form of acceptance. This means the euro is likely to strengthen. We are guessing that a 110 to 115 euro is in our future.
Add up the 5 components and one can see that they are a recipe for a rising stock market and some eventual up ticks in the rate of inflation. Inflation will not occur immediately but some time in the future because the deflationary forces in the world are very strong; however, they are being offset by this stimulus.
These five components mean bond interest rates are eventually headed higher. We are repeating our longer term target of 5.5% yield on the benchmark 10-year treasury. It will take some time for this level to be reached and it will happen coincident with robustness in economic recovery. Since the economy has had a less than fully robust recovery to date, we expect this process to take many, many months.
In sum, Investors won big this week. The economy did, too. By the way, so did the President and his policy of
combating terrorism. All in all, this is not a bad election cycle.
10/31/02: Welcome to the world of an enlarged and open Europe