Jewish World Review Dec. 23, 1999 /14 Teves, 5760
http://www.jewishworldreview.com -- BOND TRADERS LIVE IN FEAR and trembling that too many people are working, producing, consuming and importing. So the bond market is getting slammed.
The bonditos believe that too much growth causes inflation. They gagged on 3% growth a few years ago. Then 4% growth was worse. Now, 5% growth is off the charts.
Oh, my G-d. How long can this go on? It must be stopped. We've got kids to feed, private kindergartens, prep schools, Ivy League! Stop this growth, it's killing us. We've got bonuses to collect.
A lot of smart people believe that rising long rates imply higher inflation and therefore will force the Fed into a rapid-fire series of tightening moves next year. Make 1994 look like a picnic. Drive up long rates to 7%, then 8%, maybe even 9%.
Credit quality spreads are widening. Y2K is coming. The big one is out there. All caused by unending prosperity. It's got to stop.
Rapid economic growth is bad enough, but now the bonditos have to swallow a seemingly never-ending rise of the Nasdaq. Two-percent a day, every day. This thing is up 80% this year. Greenspan must hate it. Irrational exuberance gone over the edge. It will prompt even more tightening. This prosperity has got to stop.
Before my bondito friends go completely off the cliff, I have a suggestion. There is a way out. Please note the two accompanying charts. Pictures are worth a thousand words.
For most of the year bond rates have been rising in tandem with the Nasdaq stock index. But not simply market rates, rising real yields have accompanied the Nasdaq explosion. This is very important.
This year we have witnessed an abrupt technology-driven surge in real economic and investment returns. This surge in real returns has centered on the Nasdaq explosion, whose technology stocks comprise the epicenter of the new information economy.
As a consequence of these technology-linked returns, real economic growth, the real dollar exchange-rate and real interest rates have all risen together. It's one of the rare moments when rising interest rates are consistent with a rising stock market.
Why now? I don't really know. Nobel prize winner Friedrich Hayek always called the market a discovery process. This year's market seems to have discovered a technology breakthrough effect, and this is being capitalized into stock and bond prices.
Consider it yet another gale-like force released by Schumpeterian creative destruction. Perhaps it's a leap in the Internet diffusion and mass consumerization rate. Perhaps it's a breakthrough in molecular electronics, or other nano-technologies, or biotechnology, or fuel cell technology, or some other invention.
Perhaps it's the spreading globalization of the Internet, which will generate higher real returns worldwide. I note that foreign interest rates and foreign stock markets are rising in tandem with ours.
Perhaps the likelihood of U.S.-China free trade, suggested by the explosion in Hong Kong stock market prices. Or the capital gains tax cut coming in England. Or the new round of personal tax cuts in Ireland. Or the possibility of German corporate tax cuts. Or the Japanese tax cuts already in place. Or the possibility of a Chicago School president in Chile. Who knows?
We don't have to know the exact trigger for these technology breakthroughs, or the economic growth policies that nurture them. All we need to know is the market price signal which infers an explosion of new wealth. That is what the Nasdaq is telling us. And the rise of real bond yields.
Then there's a second important chart. The spread between 10-year Treasury notes and inflation-indexed 10-year Treasuries has remained steady during the second-half-of-the-year Nasdaq takeoff.
This Treasury spread has basically hovered around 200 basis points, suggesting a 2% consumer price outlook. A 2% CPI forecast is roughly consistent with about a 1% to 1 1/2% rise in broader GDP-type price indexes. In other words, virtual price stability. No need for Fed tightening.
New wealth from economy-transforming technological innovations, applications and spillovers cannot possibly be inflationary. Nor can it cause "excess demand". Remember Say's Law of Markets: true purchasing power comes only from production. We produce to consume.
Now here's some good news for the poor, oppressed bonditos. Real interest rates don't have to keep rising in order for the benefits of technology breakthroughs to keep spreading through the economy. It's the world-changing one-time breakthrough event itself that increases the productivity of capital and labor, leading to increased real interest rate returns.
But the wealth-enhancing real return-increasing technology benefits can boost the Nasdaq (though more slowly), without continuously rising real interest rates. The technology breakthrough rate slows, and real rates can descend.
What's more, high real returns to capital will attract more savings, and real interest rates can move down toward a more normal level -- though that level in a period of rapid technology advance will be higher than historical experience might suggest.
Perhaps the most intriguing part of this story is the potential for additional waves of disinflation stemming from the productivity-enhancing breakthroughs in technology. Think of it this way. If inflation is caused by too much money chasing too few goods, and if technology advances promote more goods (with greater productivity), then the future may hold more money chasing even more goods.
This is counter-inflationary. It may even result in technologically-induced deflation, which would throw off even greater economywide benefits.
It could even lead to lower market interest rates, across-the-board, in my lifetime.
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.
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