Monday, August 07, 2006

Bears on the Prowl

Judging by recessionary worries in the press and blogosphere, the cult of the bear appears to be alive and well.

The bears are focusing on housing, consumers and the slightly inverted yield curve. It's a heavy demand-side forecast approach. Supply-siders like myself look at low tax-rates on capital, high productivity, record profits, and strong industrial production.

While the jobs trend is slowing, it remains quite healthy. And 100,000 to 120,000 average monthly job gains are consistent with roughly 6 percent growth in personal income. The main point is a very low cost of capital and very high investment returns to nurture investment.

The bears ought to consider the high level of commodity prices as a sign of U.S. and world economic strength. The yield curve is not deeply inverted, but only slightly. Back in 2000 the curve was hugely inverted for about a year and the Fed deflated the money supply in 2000 after rapidly inflating it in 1999.

World political risk and uncertainty is keeping commodity prices way above equilibrium. Inflation-adjusted GDP growth is slowing toward a 3 percent trend line, but this seems more a function of rising inflation, which is crowding out real growth.

Inflation is the biggest factor in the economic outlook. If it jumps to 4 or 5 percent in the next year, then real growth will surely slump and the balance of forces could conceivably slip into recession.

An interesting thought on inflation -- industrial and energy prices have, of course, surged. But in the technology sectors prices continue to deflate.

The Fed is moving into a more restrained monetary stance, as illustrated by the decline of commodity and economic-sensitive stocks since the May 10 FOMC meeting. But there's a big difference between a flat curve and a deeply-inverted curve.

Also worth noting is that corporate credit spreads are narrow, another sign of business health and profitability. Unit prices are running ahead of unit costs, another positive for profits.

The bears also overlook the strength in business. In the last cycle, the most accurate measures of corporate profits peaked in 1997 and deteriorated through 2002. I just don't see any of this right now.

I also don’t see any imminent government policy blunders like a move to higher tax-rates, heavy regulation or protectionist tariff increases. If the Dems take over Congress come November, I think President Bush will morph into Grover Cleveland and veto Democratic tax hike proposals.

Over the next 12-18 months, prior Fed restraint will definitely slow down money GDP growth. But that same restraint should also contain inflation around the 2.5 percent zone. Hence the probability of a 3 percent real GDP trend is still reasonably high.

An abrupt oil spike to $90 or $100 would be a recessionary factor. And who can predict events in the Middle East? But back at home, the supply-side impetus within our resilient and durable free market capitalist economy is still underrated, or shall I say “misunderestimated” by the cult of the bear.