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Jewish World Review Feb. 17, 2000/ 11 Adar I, 5760

Lawrence Kudlow

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Unsettled -- THERE'S A LOT OF CRANKINESS, irritability, restlessness and discontent roiling through financial markets and the investment community. I'm not sure I have all the answers, but here are a few brief thoughts.

Just as I've never met a marginal tax-rate cut I didn't like, I've also never seen a gold price rise that ever turned me on. The technical explanation for the $30 gold jump is plausible: a couple of large gold-producing companies have decided to stop shorting the market and accept the spot gold price. In other words, it is what it is. No point in keeping hedges on that haven't paid off.

A less appetizing interpretation of the rise in gold is the money demand-reducing affects of the Fed's recent rate hike. This would be an inflationary interpretation. But I actually think Greenspan's latest move was well received by the markets. More on this in a moment.

On the money demand influence, you could factor in President Clinton's big-spending Great Society budget, which implies higher transfer and entitlement payments, leading to slower future economic growth. However, most of his proposals are not likely to pass Congress this year. Nor, regrettably, will the Republican Congress get any pro-growth tax cuts through. So the fiscal situation is a push.

Meanwhile, I've decided to resurrect our famous Golden Cone chart. I'm sure you've all been waiting for this with baited breath. Victor Canto and I conjured this thing up four years ago in San Diego. It shows that with a $310 gold price, the expected inflation rate is still less than 1% if government statisticians properly accounted for all aspects of the Internet economy. So, my heart won't fibrillate unless gold moves above $350.

The real meaning of the gold rise from $250 to $300 or so is really that global deflation has ended. But we're in the price stability zone, not a true inflationary range.

I'd be more concerned about gold if the King Dollar index was falling while gold was rising. But King Dollar is very strong, still over 104 on the index. This is 30% above its 1995 trough. The strong dollar tells me that the global demand for U.S. greenbacks is still high. It also tells me that the U.S. economy is still in good shape. And it allows me to sleep soundly at night without fretting about a puny gold move.

It's not my fault that the government bond dealing community guessed wrong on long-term interest rates. I agree that Treasury Secretary Lawrence Summers should stick to a consistent script regarding Treasury buy-backs. But the major determinant of long-term interest rates is and always will be the global bond market's expected rate of future inflation.

Now, let's give Emperor Greenspan some credit. He raised the fed funds rate and withdrew some liquidity. In response, long-term rates went down, not up. This is known as a "monetary paradox." When the central bank rate goes up, and the long-term government bond rate goes down, it generates a paradoxical effect that signals lower inflation expectations.

So does the coupon inversion of the Treasury yield curve. I still believe we've seen the peak in long rates. And I also think that the coupon inversion effect is signaling a peak in real interest rates and real economic growth. Believe it or not -- and you won't believe this if you keep reading the bond columns -- this is a good story, not a bad one. It could well mean that the year-long bear market in bonds is coming to a close.

Speaking of economic growth peaks, that is how I read the message from the underperformance of the Dow Jones relative to the Nasdaq. A hundred basis points tighter Fed is having a much greater impact on the old economy. That means the cyclical economy, which is vastly more interest rate sensitive than is the new technology economy. Thirty-eight percent of the Nasdaq 100 companies have no long-term debt. In the S&P 500, less than 1% of firms can make that claim, according to Investor's Business Daily.

When the dust clears, I think the post-Y2K year 2000 economic growth rate will be closer to 3% than 4%. Profits are likely to slow to 10% from 20%. But if long-term interest rates drop another 50 to 100 basis points, then the stock market this year will still perform decently, though not as extravagantly as has been the case in recent years.

Helping to bring down long rates, it now looks more likely that OPEC will increase production and lower prices. As I suspected two weeks ago, President Clinton has seized on George W. Bush's idea to jawbone OPEC. Energy Secretary Richardson will be visiting with Saudi Arabia et al in the next week or two. We should start to see some oil price relief in March. I'd be playing the bond story from the long side.

Yes, there is a presidential race going on out there. As is appropriate during a time of peace and prosperity, this race does not yet qualify in the top ten interesting topics for your average, normal run-of-the-mill investor class humanoid.

Let me divide the two parties into two economic categories: harm, and do-no-harm. You can guess which party goes with which category. According to most opinion polls, Bush leads Gore by 10 percentage points, and McCain leads Gore by nearly 20 percentage points.

Both Republicans are free-market, pro-entrepreneur, pro-Internet economy, and pro-free trade. Neither are sufficiently pro-investor class; they both are ignoring lower cap gains and unlimited super-saver IRA accounts. But as they carpet bomb each other on the way to next Saturday's South Carolina primary, let's not lose sight of the big picture: neither one will do any economic or investment harm, and it is still at least theoretically possible that they might do some good.

JWR contributor Lawrence Kudlow is chief economist for Schroder & Co. Inc and CNBC. He is the author of American Abundance: The New Economic & Moral Prosperity. Send your comments about his column by clicking here.


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