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Jewish World Review Aug. 31, 1999 /19 Elul, 5759

Lawrence Kudlow

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Bull Market Alive and Well --
WITH ALL THE NEAR-MANIACAL obsessing over Fed policy, investors, especially longer-term investors (the only serious wealth-creating investment is long-term) should not lose sight of the large number of very positive developments in the economy. Including the far-reaching impact of the Internet. The long bull market cycle of prosperity is alive and well, Fed or not.

Here's the good news. Treasury bond rates have peaked. Consumer price inflation, though still over-reported from the absence of proper accounting for information technologies, is running at only 1.7% annually year-to-date, excluding the temporary oil shock. This is considerably less than last year's 2.4% pace.

Technology investment is running at a phenomenal 40% annual pace, thereby expanding the economy's long-run potential to grow. Using this technology, worker productivity is increasing 5% per year in the factory sector (the only accurate output-per-hour count), 4 1/2% annually in non-financial corporate America and 3 1/2% for overall non-farm business. So, in general, productivity rates exceed the 3 1/2% to 4% rise in worker wages and salaries.

Therefore, business profits through mid-year have risen 16 1/2% from 1998, including a 44% gain for computers and software, a 41% rise in durable goods, 38% in telecommunications, 30% for retailers, 15% for financial services, and 12% for capital goods and health care. This explains yearly stock market gains of 31% for the Dow, 24% for the S&P and 53% for the Nasdaq. Pretty impressive wealth creation.

There's still more. Industrial production is rising 3.6% above a year ago, while factories' capacity to produce is growing at a 4.1% rate. So the supply-side of the economy is expanding rapidly, leaving plenty of room for future growth without straining resources.

Historically low interest rates and inflation are driving the deregulated economy, along with rapid technological advances and equally rapid business spillovers and consumer diffusion rates. Speaking of diffusion rates, the U.S. Internet Council reports that it took fifty years for electricity to reach 30% of U.S. households, but the Internet has done it in only seven years. It took personal computers thirteen years; radio and television took twenty-five years. The whole economy is on technological fast-forward.

Right now, the Internet is more important than the Fed. Much more important. Easily accessible low-cost information and increased competition, the hallmarks of Internet economics, will contribute substantially more growth with significantly lower prices. Think of it as deflationary growth, a classic consequence of long-wave technology cycles. This is the new paradigm of the information economy. Right out of Joseph Schumpeter's playbook.

Two more factoids on this point. Over the past year computer production has increased 41.5%, while computer prices in the CPI have fallen 30%. Deflationary growth.

Look for the Internet wave to intensify and expand, with profoundly positive consequences for the stock market and the economy. Record-breaking venture capital investment is nurturing Internet innovation, and high technology in general. PricewaterhouseCoopers reports that venture-backed investments in 1999's second quarter hit a record $7.7 billion, a 104% rise over last year, and far above the previous record of $4.3 billion in the first quarter of 1999.

Internet-related company financing quadrupled to $3.8 billion, up from $947 million in Q2 1998. The number of companies receiving funds more than doubled to 412 from 174. Investments in this year's second quarter exceeded the total for all of calendar 1998.

Meanwhile, companies in Biotechnology, Communications, Computer and Peripherals, Electronics, Environmental, Medical devices, Semiconductors, Software and Information, plus Internet, accounted for $6.9 billion, or 90% of all venture cap investments in second quarter 1999.

Venture capital is the lifeblood oxygen pipeline of technology advance, which itself is the backbone of the New Economy. Embryonic technology ventures require seed capital in order to be commercialized and then mass consumerized. These record venture capital flows, undoubtedly bolstered by the recent decline in the Federal tax-rate on capital gains, and the strong possibility of yet another capgains tax cut in the near future, point toward an even greater velocity rate for technological innovation in the next century.

Now back to the Fed. Regrettably, Greenspan & Co. continue to stray off the price rule. Instead, they have wandered into the historical back alley of Malthusian limits to growth and employment.

This old economy thinking, embalmed by the discredited Phillips curve trade-off between inflation and unemployment, reflects the tired wisdom of the ivied economics establishment, perhaps the most retrogressively conservative institution in politics today. Promoting the incongruous policy prescription of higher interest rates and paydowns of the Federal debt, they have even abandoned the original Keynesian first principle of growth.

Growth is the DMZ intellectual dividing line in contemporary American politics. In economics, free market supply-siders embrace it; orthodox economists doubt it. Culturally, optimists favor growth, while pessimists reject it. Ideologically, slumps born of austerity policies open the door for economic planners and bigger government influence. In other words, statism. However, prosperity from free enterprise growth policies has no need for government targets and controls. The free market is the most effective regulator of resources.

In monetary policy, market prices are the most efficient regulators of the supply and demand for money. With gold low and the dollar index high, it is clear that the volume of money provided by the Fed is just about right. There is no need to withdraw liquidity or attempt to fine-tune the economy's growth rate. Today's growth is real, not inflationary.

Hopefully, Mr. Greenspan will soon move back to the price rule. That is the history of his tenure; Phillips curve relapses never seem to last long. Message to the Fed: Do no harm.

However, if the economic establishment in and out of government continues to press austerity and pessimism, they will be confronted by a political tidal wave of opposition from the shareholders, farmers, seniors, homeowners, website operators and users, venture capitalists, small business proprietors and others who I term the new Investor Class. These asset owners believe that market incentives, not government planners, create wealth. They are fundamentally optimistic people who devoutly believe that more growth and prosperity and people working is a good thing.

They will not permit new tax, inflation, trade and regulatory obstacles to impede free enterprise. They know that entrepreneurship spells opportunity. Insofar as politics, they will vote their portfolios to reduce government obstacles. They are young and old, rich and unrich, black, white and brown, men and women.

In their lifetime, they have seen that enhanced economic freedom over the past two decades has unlocked the benefits of science, technology, knowledge and information to ordinary people. This, in turn, has unleashed their God-given talents to prosper, provide service and achieve greater happiness. Having tasted the fruits of this prosperity, they will seek more, not less.

Think of the Internet as an economic freedom metaphor for our time. The Internet empowers ordinary people and disempowers government. The Internet creates wealth, expands growth, produces jobs and spreads prosperity. Standing behind the Net is the political power of well over 100 million investors and asset owners.

Because of this, I believe the future economy will outperform all expectations. The stock market will head toward 15,000 in a few years, then 30,000, then 50,000 and higher. Believe it or not, the Internet is more important than the Fed.

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.


08/26/99:Let Prices Rule
08/19/99: Blame OPEC, Not Growth

©1999, Lawrence Kudlow