Friday, December 21, 2007

Bush’s Very Good Year

Against all odds, and despite the usual drumbeat of criticism, President George W. Bush has had a very good year. The troop surge in Iraq is succeeding. America remains safe from terrorist attacks. And the Goldilocks economy is outperforming all expectations.

At his year-end news conference, President Bush stated with optimism that the economy is fundamentally sound, despite the housing downturn and the sub-prime credit crunch. The very next day, that optimism was reinforced with news of the best consumer spending in two years. The prophets of recessionary doom, such as former Fed chair Alan Greenspan, Republican advisor Martin Feldstein, ex-Democratic Treasury secretary Lawrence Summers, and bond-maven Bill Gross have been proven wrong once again.

Calendar year 2007 looks set to produce 3 percent growth in real GDP, nearly 3 percent growth in consumer spending, and over 3 percent growth in after-tax inflation-adjusted incomes. Meanwhile, headline inflation (including food and energy) will have run at 2.5 percent, with only 2 percent core inflation.

Jobs are rising over 100,000 per month and the stock market is set to turn in a respectable year despite enormous headwinds. Low tax rates, modest inflation, and declining interest rates continue to boost Goldilocks, which is still the greatest story never told.

Bush’s optimism is well-earned, in Congress too. He has stopped a lot of bad legislation on higher taxing and spending. He won on S-CHIP and the alternative minimum tax. He mostly prevailed on domestic spending. And he got much of what he wanted on war funding without any pullout dates.

And he’s not yet finished. In the most dramatic statement of his holiday news conference, Bush said he will not stand for the continuing congressional proliferation of pork-barrel earmarks.

“Another thing that’s not responsible is the number of earmarks the Congress included in the massive spending bill,” said Bush. “The bill they just passed includes about 9,800 earmarks. Together with the previously passed defense spending bill, that means Congress has approved about 11,900 earmarks this year. And so I am instructing budget director Jim Nussle to review options for dealing with wasteful spending in the omnibus bill.”

This is huge. The statute of limitations for Republican overspending, over-earmarking, and over-corrupting that caused huge congressional losses in last year’s campaign will not run out until the GOP shows taxpayers that it again can be trusted on the key issues of limited government and lower taxes.

In these matters, Republicans must be holier than the pope. And while President Bush has been doing the Lord’s work with his newfound veto pen, he must continue to wage war on earmarks if the GOP is to cleanse the political memory of Tom DeLay, Jack Abramoff, and Randy “Duke” Cunningham.

Think of it: This behemoth spending-bill was porked-up with such essential items as rodent control in Alaska ($113,000); olive fruit-fly research in France ($213,000); a hunting and fishing museum in Pennsylvania ($200,000); a bike trail in Minnesota ($700,000); a post office museum in Las Vegas ($200,000); and a $2 million monument to Rep. Charlie Rangel in New York.

Senators like Jim DeMint, Tom Coburn, and John McCain are working hard to clean up the earmark process. But the ball’s in the president’s court. Either through executive order, recission authority, or apportionment of funds, Bush can elevate both the fiscal fortunes of the nation and the political fortunes of his party.

Senate Republican leader Mitch McConnell told me in a CNBC interview that elected politicians are more knowledgeable about spending people’s money than faceless bureaucrats. And while McConnell has done a terrific job maintaining conservative policies in the Senate, he is wrong on this topic. The earmarks shouldn’t be made. And the money shouldn’t be spent. Period.

McConnell is nevertheless correct that passage of this omnibus spending bill is a defeat for the tax-and-spend-happy Democrats. Republicans also can take credit for outmaneuvering the Democrats on a patch for the AMT. The Democrats were made to waive the pay-as-you-go budget rule that might have forced tax increases on businesses and investment pools. Stopping this tax hike is a singular GOP achievement, while the AMT will now be indexed for inflation, thereby sparing over 20 million taxpayers.

Looking ahead, the economy also would benefit from a corporate tax cut for both large and small businesses, including corporate capital-gains. The U.S. dollar would reap the rewards as new investment would flow in from the world. Several recent studies also show that businesses would pass on tax-cost savings to the workforce, thereby bolstering wages and ultimately creating new jobs.

Hokey ideas for temporary tax rebates? They should be ignored. But if the president and Republicans are successful at wiping out earmarks, holding down spending, and passing a bold corporate tax cut, Goldilocks will be nourished and sustained. And come November 2008, Republicans might be back in the driver’s seat.

Friday Night Lineup

On CNBC's Kudlow & Company at 7pm ET tonight:

THE MARKETS...Our market panel will discuss and debate all the latest news and developments affecting investors.

On board:

*Joe Battipaglia, Stifel Nicolas market strategist
*Michael Metz, chief investment strategist at Oppenheimer & Co.
*Mark Skousen, author and editor of Forecasts & Strategies
*Jerry Bowyer, chief economist at Benchmark Financial Network/NRO contributor
*Stefan Abrams, Bryden-Abrams Investment Management managing partner

BUDGET, SPENDING, & EARMARKS...Joining us to discuss what's going on down in Washington will be fiscally conservative Senator Tom Coburn (R-OK).

YOUR MONEY, YOUR VOTE...Pollsters Scott Rasmussen of Rasmussen Reports and John Zogby of Zogby International wil be aboard. They will discuss the surging campaigns of Mike Huckabee, John McCain, and other developments in the 2008 campaign.

POLITICAL DEBATE...Duking it out over the presidential sweepstakes will be conservative columnist Ann Coulter and Mike Farris, a longtime social conservative activist backing Mike Huckabee.

Please join us at 7pm ET on CNBC for another free market edition of Kudlow & Company.

China Gets a Haircut

Here’s one of the biggest stories of 2007. It’s truly amazing. It raises all sorts of questions.

According to new World Bank figures, China’s GDP is overestimated by 40 percent.

China is a much smaller economic power than once believed. It’s not nearly as big, not nearly as important, not nearly as imposing.

The figures that the World Bank and others had been using to estimate China’s economy compared to ours based on purchasing power parity (PPP) were forty percent too high (India too). As Walter Russell Mead from the Council on Foreign Relations explained on last night’s Kudlow & Company, this means the balance of power in Asia is probably more secure than once believed.

Under the old PPP numbers, China was poised to pass the U.S. as the world’s largest economy in 2012. That isn’t going to happen. China is much smaller than we thought. It will not be overtaking the United States anytime soon.

This story reminds me of how, for many years, intelligence estimates vastly overrated the strength of the old Soviet Union economy.

Wesbury Sees Growth Ahead

An excerpt from last night's Kudlow & Company:

“Let me just point out that without housing, 3rd quarter GDP was 6 percent annualized growth. You have to remember that going back into the 2nd quarter, [bearish economist] Nouriel [Roubini] and others were saying 3rd quarter was only going to have 2 percent growth. So these pessimists have been way, way, wrong on the low side. They have been continually blown out of the water by stronger than expected data.

And I don’t care what weekly chain store sales are saying, and all of these things. We’ve constantly had revisions upward. We’ve constantly had better news. And I think all you have to do is go outside. You can’t get a parking spot at the mall; you have to wait in line to get a table at a restaurant; you get middle seats on the airplane. There’s no evidence that this economy is slowing down.” -Brian Wesbury, Chief Economist at First Trust Advisors

Thursday, December 20, 2007

Thursday Night Lineup

On CNBC's Kudlow & Company at 7pm ET tonight:

RECESSION OR NOT?...On to debate are Nouriel Roubini, NYU economics professor & chairman of Roubini Global Economics and Brian Wesbury, First Trust Advisors chief economist.

A HARD LOOK AT CHINA...Our panel will offer its perpsective on news that China's GDP may not be all that it's cracked up to be.

On board:

*Pat Buchanan, conservative political pundit
*Bob Hormats, vice-chairman of Goldman Sachs International
*Charlie Gasparino, CNBC’s On-Air Editor
*Walter Russell Mead, Henry A. Kissinger Senior Fellow for U.S. Foreign Policy at the Council on Foreign Relations

THE MARKETS...Our market panel will discuss and debate all the latest news and developments affecting investors.

On board:

Jim LaCamp, portfolio manager at RBC Dain Rauscher
John Browne, editor of
Charlie Gasparino, CNBC’s On-Air Editor

MONEYPOLITIC$ POLLS...CNBC chief Washington correspondent John Harwood will deliver the goods on what all the latest polls are saying about the 2008 presidential race.

THE WHITE HOUSE CLIMATE AGREEMENT...Jim Connaughton, Chairman of the White House Council on Environmental Quality will be aboard to discuss.

Please join us at 7pm ET on CNBC for another free market edition of Kudlow & Company.

Ending Earmarks

I’d like to see President Bush rescind the earmarks contained in the massive omnibus spending bill.

As today’s Wall Street Journal points out, the president does have the power to rescind. He ought to use it. It would mean that congress would have to go back and restore the rescinded funds. As I understand it, this would require a ¾ majority, an unlikely outcome since republicans will likely stand behind the president.

The Bush strategy would be to sign the appropriations bill, fund the troops, and fund the government, but knock out those corrupt earmarks. The point to this strategy is to keep the GOP on its recovery path from the electoral setback a year ago, when independent voters punished republicans for over-spending, over-earmarking and over-corrupting.

Republicans must complete their 12-step recovery program. The GOP must be holier than the Pope in fiscal affairs. This would shake the Democrats’ criticism of GOP profligacy. It would also help republican presidential candidates out on the campaign trail.

Mr. Bush has been doing the Lord’s work lately with spending vetoes and veto threats. In fact, during his news conference today, Bush said the omnibus spending bill has too much wasteful spending for lawmakers’ pet projects. He said, “I am instructing budget director Jim Nussle to review options for dealing with wasteful spending in the omnibus bill.”

This is good. He must continue to wage war on earmarks. Meanwhile, the Democrats are playing into his hands, since they wanted even more earmarks (and of course even more spending and more taxing). And so far as I know, the Dems have not put forward a single spending cut in this session of Congress. Not one.

If Mr. Bush acts forcefully to rescind these earmarks, the statute of limitations on GOP spending excess will eventually expire in 2008.

Just in the nick of time?

Wednesday, December 19, 2007

Wednesday Night Lineup

On CNBC's Kudlow & Company at 7pm ET tonight:

THE FED, THE MARKETS & MORE...Our market panel will discuss and debate all the latest news and developments affecting investors.

We'll begin with a one-on-one interview with former Federal Reserve Governor Wayne Angell.

Also on board:

*Ben Stein, economist, actor, and lawyer
*Dennis Kneale, CNBC media and technology editor

THE CREDIT MARKET...Dr. Mark Greene, CEO of Fair Isaac (a maker of credit-scoring systems for insurers and lenders) will join Messrs. Stein and Kneale with his perspective.

AN INTERVIEW WITH MITCH MCCONNELL...Senate Minority Leader Mitch McConnell (R-KY) will be aboard this evening with an update from Capitol Hill.

AN INTERVIEW WITH CHARLIE RANGEL...House Ways and Means Chairman Charlie Rangel (D-NY) will fill us in on what's going on with taxes.

MONEYPOLITIC$...Robert Reich, former Clinton Labor Secretary will join Ben Stein in a discussion and debate following the interviews.

Please join us at 7pm ET on CNBC for another free market edition of Kudlow & Company.

Kudlow 101: Milton Friedman Rides Again

There are fresh signs that we are on the verge of a major inflationary plunge.

We recently took a closer look at the relationship between M1 and inflation. Here’s what we found. Since the early 1990s this relationship has improved dramatically. And over the last six years or so, this correlation has remained strong. This surprised me. I hadn’t looked at this in a long time. There is a clear link to prices and a plunging future inflation rate. This is classic Friedman monetarism.

Take a look at this picture of the CPI inflation rate:

Contrary to the recent flare-up of inflation last week, we are actually going to get a somewhat lower inflation rate this year of around 2.7 percent. Inflation was running at 3.2 percent in 2006 and 3.4 percent in 2005. So even though we had a bad number in November, calendar year-to-date, it’s actually lower than the prior two years.

Now let’s take a look at the M1 money supply. M1 is simply currency in circulation plus other checkable deposits. Milton Friedman used this. And it also happens to be part of the reason why inflation is coming down.

In the beginning of this decade, M1 was rising rather rapidly. It came in at 3.3 percent back in 2001, rose again the following year, and eventually peaked at 6.5 percent in 2003. But it has been coming down ever since. In fact, M1 came in at 2.0 percent in 2005, 0.2 percent in 2006, and calendar year-to-date, it’s actually in negative territory at minus 0.3 percent.

Money is the ultimate cause of inflation. Inflation is everywhere a monetary phenomenon. Therefore, since M1 growth has essentially collapsed, we are now looking at a big drop in CPI inflation.

Take a close look at this chart. With a two-year time lag, we’re looking at a roughly 1.5 percent inflation rate. Maybe even less.

As University of Michigan economist and Carpe Diem blogger Mark Perry told me, this relationship is not a direct, one-to-one relationship. In other words, there is about a 2 or 3-year lag, since money growth takes this amount of time before it has its final impact on prices.

There is no perfect, silver-bullet, forecasting device for inflation. And while this monetarist model revived by Mark Perry is interesting and statistically significant, no one can say for sure that this is the ultimate method of predicting inflation. That said, money still looks tight from the standpoint of an inverted yield curve and a near zero growth of the monetary base.

If these views are correct, now is the time to sell gold and buy the dollar.

Tomorrow we’ll take a look at the velocity (or turnover rate) of money and compare that to gold in the context of this monetary approach. Monetarist models of inflation have had their ups and downs over last 30 years, but so have commodity models of inflation. The trick is to use some common sense to evaluate the whole story.

But the key point here is that inflation looks like it’s going to plunge.

Tuesday, December 18, 2007

The McCain Interview

(Here's a little taste of my interview with GOP presidential hopeful Sen. John McCain from earlier this afternoon. You can catch the whole interview on CNBC's Kudlow & Company tonight at 7pm ET.)

KUDLOW: Let me pitch you a classic Democratic pessimistic statement from Senator Charles Schumer, who was on this network yesterday. He says the following, "Bush administration continues to see the economy through rose-colored glasses, whether it's subprime crisis, the credit crisis, the energy crisis, the declining dollar, or it just blithely marches on without making any serious effort to solve these economic problems." What would your response be to Mr. Schumer?

Sen. McCAIN: My response is take a trip out Silicon Valley. Take a trip to many of the small businesses and enterprises that are growing and look at our revenues, which are dramatically increasing as a result of the exports of the quality products that can compete around the world.

Look at the young men and women who are not only on Wall Street, but every small and big business in America. Look at our fundamental underpinnings of our economy and the fact that, still, every innovation in the cutting edge of high technology still comes from the United States of America.

Do we have challenges? Yes. I'm not looking through rose-colored glasses. We've got to continue education reform. We've got to do a better job on health care reform, fix these unfunded liabilities with Social Security and Medicare.

But I see no problem. I see no problem that we can't surmount with the American people working together. And I see a very bright future for us in the information technology revolution which the world is going through today.

Tuesday Night Lineup

On CNBC's Kudlow & Company at 7pm ET tonight:

THE MARKETS...Our market panel will discuss and debate all the latest news and developments affecting investors.

On board:

*Don Luskin, chief investment officer at Trend Macro
*Dennis Kneale, CNBC media and technology editor
*Michael Panzer, trader/author of "Financial Armageddon"

THE MCCAIN INTERVIEW...Joining us for a one-on-one interview will be GOP presidential hopeful Sen. John McCain. We will explore a number of subjects including the upcoming contests in Iowa and New Hampshire, taxes, and the economy.

MONEYPOLITIC$ PANEL...On to discuss the McCain interview will be The Club for Growth's Pat Toomey and CNBC's Dennis Kneale.

INFLATION & THE ECONOMY...On to debate will be economist Bob Stein from First Trust Advisors and University of Michigan B-School professor Mark Perry who also hosts the Carpe Diem blog site.

Please join us at 7pm ET on CNBC for another free market edition of Kudlow & Company.

My Chat with McCain

Tonight on Kudlow & Company I’ll be talking with GOP presidential hopeful Sen. John McCain about recent powerhouse endorsements from key newspapers (The Des Moines Register, The Boston Globe, Portsmouth Herald, New Hampshire Union-Leader), a ringing endorsement from Sen. Joe Lieberman, and how he plans to pull off a big surprise win in New Hampshire.

McCain has a very solid pro-growth economic plan. He’s for keeping tax rates low and abolishing the AMT. He’s also tough on spending and, of course, tough on earmarks.

The million-dollar question is whether McCain can bring disenchanted investors and political independents back to the GOP fold and into his voting-booth column.

But rest assured, McCain is very much alive.

Please join us at 7pm ET on CNBC.

Monday, December 17, 2007

Monday Night Lineup

On CNBC's Kudlow & Company at 7pm ET tonight:

MONEY POLITIC$...We'll cover all the hot-button issues explored during President Bush's remarks today including the economy, taxes, energy reform, and healthcare.

The Dynamic Duo - former Labor Secretary Robert Reich and The Wall Street Journal's Steve Moore - will be on to debate.

THE CONSUMER, THE ECONOMY & MORE...Mark Skousen, author and editor of Forecasts & Strategies will offer his take. The Dynamic Duo will also weigh in.

THE MARKETS...Our market panel will discuss and debate all the latest news and developments affecting investors.

On board:

*Quentin Hardy, Forbes magazine Silicon Valley Bureau Chief
*Garry Shilling, president of A. Gary Shilling & Co.
*Mark Skousen, author and editor of Forecasts & Strategies
*Jerry Bowyer, chief economist at Benchmark Financial Network/NRO contributor

CZAR PUTIN?...On to discuss Russia's future will be former Secretary of State Lawrence Eagleburger.

The market panel will weigh in with their perspective following the Eagleburger interview.

Please join us at 7pm ET on CNBC for another free market edition of Kudlow & Company.

The Inflation Debate Continues

Ace Carpe Diem blogger Mark Perry of the University of Michigan business school has some really interesting charts and analyses showing the link between M1 and inflation.

Perry argues that M1 has been basically flat for three years now. As a result, future inflation is heading lower, not higher. It’s an old fashioned, Milton Friedman type monetarist argument.

Incidentally, Caroline Baum also has a Bloomberg column highlighting the European Central Bank’s monetarism. All this stands in stark contrast to the WSJ editorial this morning, Money Illusions.”

So the inflation debate continues.

I believe that a very slow 2 percent monetary base growth, along with an inverted Treasury yield curve, and a 3 month T-bill rate that is over a hundred basis points underneath the 4.25 fed funds rate all indicate tight money from the Fed. This is essentially Art Laffer’s view as well.

But I must confess, I do wish gold were $300 dollars lower.

National Review's Man of the Year

I totally agree.

** Click here to read the whole NR editorial.

** Click here to read my thoughts from Friday, "The Surge is Surging."

Friday, December 14, 2007

The Surge is Surging

Don’t look now, but the Petraeus surge is surging.

Surging Media: Yesterday, a USA Today editorial acknowledged the surge is working. The headline reads, “Surge’s success holds chance to seize the moment in Iraq.” The paper says, “Democrats are lost in time.” Moreover, U.S. and Iraqi casualties are down sharply. In fact, U.S. military deaths are down to their lowest level in twenty months. Also, Sunni groups, once sympathetic to al-Qaeda, have shifted allegiances. They are now working alongside U.S. forces. Over on the Shiite side, “about 70,000 local, pro-government groups, a bit like neighborhood watch groups, have formed to expose extremist militias.”

Surging Oil: There’s a big story in the Wall Street Journal yesterday about Iraqi oil output surging back to prewar levels (“Iraqi Oil Is Easing Supply Strain”). According to the WSJ, Iraqi output is back to about 2.5 million barrels a day. In addition, average oil exports in November came in just shy of 2 million barrels a day. That’s a post-invasion record. Meanwhile, the Iraqi government is using some of this revenue, around $2 billion, to invest in their decrepit infrastructure. Sure, it’s going to take more money than that to get real improvements, but it’s a good start and an encouraging signal.

Surging Bonds: Bloomberg reports that, “[Iraq’s] $2.7 billion of 5.8 percent bonds due in 2028 returned 15.2 percent since July, according to JPMorgan Chase & Co. index data. Only Ecuador’s debt gained more, rising 18 percent.” Iraqi bonds were trading at 55 cents on the dollar last August, with an 11.5 percent yield. Today, they have rallied to 64 cents, bringing the yield down to 9.9 percent. U.S. money managers are saying these are the hottest bonds in the emerging market. This is a clear sign of confidence in the conduct of the war. After all, the folks swooping up this debt have money on the line. They are backing up opinions with real money. One bond manager who oversees $14 billion says, “There’s optimism the surge is starting to pay off.”

Friday Night Lineup

On CNBC's Kudlow & Company at 7pm ET tonight:

THE MARKETS...Our market panel will discuss and debate all the latest market news, trends, and developments and what lies ahead for investors.

On board:

*Fritz Meyer, senior investment officer with A I M Advisors
*Joe Battipaglia, Stifel Nicolas market strategist

CNBC's Charlie Gasparino will join the market panel debate later in the show.

THE FED, THE ECONOMY & INFLATION...Our economic panel will weigh in with their perspective.

On board:

*Wayne Angell, former Federal Reserve Governor
*Bob McTeer, former President of the Federal Reserve Bank of Dallas
*Krisha Guha, Financial Times Chief U.S. Economics Correspondent

1972 ALL OVER AGAIN?...On to debate Hillary Clinton's sagging fortunes and other developments in the 2008 presidential sweepstakes are political commentator Lawrence O'Donnell and Kellyanne Conway, president of the polling company.

ENERGY BILL DEBATE...On to debate are The Cato Institute's Jerry Taylor and Daniel Weiss, director of climate strategy at the Center for American Progress.

Please join us at 7pm ET on CNBC for another free market edition of Kudlow & Company.

1972 All Over Again?

Could Hillary Clinton be the Ed Muskie of the 2008 presidential campaign?

Muskie’s nomination in 1972 was thought to be a done deal. He had the smartest and most prestigious staff organization, as well as scores of endorsements from important Democrats. Turned out he was a paper tiger. Muskie collapsed in New Hampshire when he cried on a flatbed truck in front of the Manchester Union-Leader, which had attacked Mrs. Muskie for drinking too much.

Well before that episode, Muskie’s fuzzy message, lackluster campaigning, and refusal to take clear positions had doomed his effort below the surface. George McGovern nearly beat Muskie in New Hampshire that year and of course went on to win the nomination. Muskie’s people thought he had a firewall in Florida and Illinois to stop the hemorrhaging begun in New Hampshire. It was not to be. Muskie was completely unhorsed.

Might history be repeating itself?

Inflation Drilldown

Inflation flared up in November with disappointing reports on import prices, producer prices, and consumer prices. But it looks worse than it really is. A burst of oil and gasoline price increases, plus very low 12-month comparisons should be put into context.

For example, over the first 11 months of 2007, the headline CPI (with energy and food) is up 2.7 percent compared to 3.3 percent in 2006 and 3.4 percent in 2005. Chained CPI (which allows more freely for substitution effects and transaction price updates) was up 2.9 percent in 2005 and 2006, but only 2.4 percent in the first 11 months of 2007.

On a core basis, the chained CPI index is up 2.0 percent this year, versus 2.3 percent last year and 1.9 in 2005. No matter how you slice the pie, the CPI peaked in the summer of 2005, while the core measure peaked in the fall of 2006.

I continue to believe that an inverted Treasury yield curve and a rock bottom 2 percent growth in the monetary base suggest tight money and lower future inflation. Some commodities watchers dispute this and I appreciate the disagreement. Incidentally, the price deflator for non-farm business has eased to 1.5 percent over the four quarters ending in Q3 from a peak of 3.5 percent in the middle of 2005. And durable goods prices continue to decline.

But I still believe that the shape of the Treasury curve and the increase in the level of the monetary base, as well as the 5 year forward TIPS spread in the bond market, have proven to be better inflation indicators in this cycle.

The latest inflation readings are likely to have only minimal impact on Fed policy. To solve the credit crunch in commercial paper and Libor, Bernanke & Co. have much more to do in order to right the upside down yield curve.

Thursday, December 13, 2007

The Fed's Blowing Smoke

The Fed is blowing smoke, pure and simple.

There is only way to clear up overly tight money and the credit squeeze and that is to slash the federal funds rate. Or, better yet, let it float - add just enough new money to right the anti-growth yield curve.

All of this extra liquidity facility discount window talk is a bunch of rigmarole. It didn't work last August, and it ain't gonna work now.

This latest news about the term auction facility reserve adding process is merely a tactic to buy time before the next FOMC meeting on January 30th. And the overnight indexed swap rate is 4.098 percent, which is a slightly lower cost of money from the new 4.25 percent fed funds rate. So there’s a tiny advantage for bank borrowers.

But banks can bid for fed funds in the overnight market right now. The problem is that the current 4.25 percent fed funds rate is too high, relative to the entire Treasury yield curve, which is anchored by a 91-day T-bill rate that’s below 3 percent. The Fed needs to right the inverted yield curve. That’s why they have to be more aggressive in bringing their target rate down much more.

In the months ahead, the fed funds rate will land somewhere near 3.5 percent. And a “shock and awe” 50-basis point cut Tuesday would have brought down the London Inter-Bank Overnight Rate (LIBOR). That by the way, would have helped out struggling adjustable rate mortgage holders.

In the end, Goldilocks is going to win because the Fed will finally get the drill. They are going to cut the funds rate many more times. The academic bureaucrats will finally come to their senses. But their performance this week has been nothing short of pathetic.

The bottom line here is simple: The Fed is moving way too slow.

Thursday Night Lineup

On CNBC's Kudlow & Company at 7pm ET tonight:

THE MARKETS...Our market panel will discuss and debate all the latest market action and what lies ahead for investors.

On board:

*Doug Kass, President of Seabreeze Partners Management
*Noah Blackstein, portfolio manager at Dynamic Mutual Funds
*Don Luskin, chief investment officer at Trend Macro

OIL & ENERGY...Dan Yergin, chairman of Cambridge Energy Research Associates will join the market panel with his perspective.

GOLD, INFLATION, THE ECONOMY...John Tamny, editor of RealClearMarkets will discuss and debate with Jerry Bowyer, chief economist at Benchmark Financial Network/NRO contributor.

YOUR MONEY, YOUR VOTE...CNBC chief Washington correspondent John Harwood will deliver an update on all the latest political news & developments.

*ALSO...Democratic presidential candidate and Delaware Senator Joe Biden will join us in a one-on-one interview on a host of hot-button topics including the war in Iraq and the economy.

STEROIDS: THE MITCHELL REPORT...CNBC's Sports Business Reporter Darren Rovell will offer his take on the steroids in baseball controversy amidst today's report.

Please join us at 7pm ET on CNBC for another free market edition of Kudlow & Company.

The Pope Condemns Climate Change Prophets of Doom

Take that Algore.

From the Daily Mail:

"Pope Benedict XVI has launched a surprise attack on climate change prophets of doom, warning them that any solutions to global warming must be based on firm evidence and not on dubious ideology.

The leader of more than a billion Roman Catholics suggested that fears over man-made emissions melting the ice caps and causing a wave of unprecedented disasters were nothing more than scare-mongering.

The German-born Pontiff said that while some concerns may be valid it was vital that the international community based its policies on science rather than the dogma of the environmentalist movement..."

Click here to continue reading.

Wednesday, December 12, 2007

Wednesday Night Lineup

On CNBC's Kudlow & Company at 7pm ET tonight:

THE MARKETS...Our market panel will discuss and debate all the latest market action, volatility, and what lies ahead for investors.

On board:

*Michael Metz, chief investment strategist at Oppenheimer & Co.
*Quentin Hardy, Forbes magazine Silicon Valley Bureau Chief
*Michael Panzner, trader/author of "Financial Armageddon"
*Dennis Kneale, CNBC media and technology editor

THE FED & THE ECONOMY...Our economic panel will lend its insight on all the key issues and developments affecting the economy.

On board:

*Jim Glassman, senior economist at JP Morgan Chase
*Joe LaVorgna, chief US economist at Deutsche Bank
*John Ryding, chief economist at Bear Stearns

THE KERRY INTERVIEW...We'll have a one-on-one interview with Sen. John Kerry (D-MA) discussing the one-year SEC proposal to delay requiring small public companies to comply with Sarbox's stricter accounting requirements. We'll also discuss the Fed and the AMT.

TWO PRESIDENTS IN THE WHITE HOUSE?...Sally Bedell Smith, author of "For Love of Politics: Bill and Hillary Clinton: The White House Years" as well as yesterday's WSJ op-ed on this subject, will debate Lisa Caputo, former press secretary to First Lady Hillary Clinton and Citigroup Chief Marketing Officer.

Please join us at 7pm ET on CNBC for another free market edition of Kudlow & Company.

Kudlow 101: The Fed Has More Work to Do

Here’s why I wanted 50 basis points from the Fed, and why I believe the U.S. central bank still has more work to do.

The following charts illustrate why there’s still not enough liquidity, and why the credit clogging and short-term funding markets need some help.

Let me begin with the yield curve spread. (This is the 10-year less the fed funds rate.)

Notice what has been happening. Since mid-2005, this spread has gradually turned negative. Look at that move. First it flattened, then it continued on, eventually turning negative. It is still inverted. It has been 18 consecutive months. It is still inverted by about 18 basis points. It’s been a year and a half since the fed funds rate was above the 10-year rate. That is unsustainable. It is a recession warning.

Okay, next chart—adjusted monetary base.

This is the basic money supply measure controlled by the Fed. When they buy bonds, they inject cash into the economy. That adds to the money supply. When the Fed sells bonds, they withdraw cash from the economy. That subtracts from the money supply.

As the yield curve got tighter and tighter, the Fed’s monetary base got slower and slower. This goes back to 2003. It started this journey at 8 percent and is now at only 2.1 percent. Guess what? If you can’t borrow short to lend long, then the whole money supply creation and credit creation process is turned upside down. That’s what we’ve experienced. The Fed has got to make a correction. The fed funds rate has got to get down below the 10-year rate.

The next chart illustrates the credit clogging. It shows 30-day asset backed commercial paper compared to the fed funds rate.

Short-term funding markets are clogged up. They’re not working. Businesses are having trouble getting overnight loans. If this isn’t corrected then the economy will falter.

You’ll notice that it’s actually worse than it was this past summer. Last summer it got as high as 108, and then fell quite a bit to 13. But look at what’s happened in the last month or two. It’s gone all the way back up to almost 200 basis points. This is what the Fed’s Donald Kohn was talking about recently. This is why people thought the Fed was going to be more aggressive yesterday.

And finally, let’s take a look at the London interbank market.

The dollar spread is almost to where it was last summer. Look at what’s happened in the last couple months. It’s back up over 100 basis points.

These are all reasons why the Fed has got to unclog these credit markets. They’ve got to right the yield curve and provide more money supply growth in the form of the monetary base.

Tuesday, December 11, 2007

Today's Baffling Fed Decision

Well, I guess the stock market didn’t much care for today's Fed decision.

Turns out the bond market outside of Treasuries didn’t like it either. Corporate bond rates went up while credit spreads widened. It’s kind of a rush to safe haven. It’s not good for economic growth.

I'm not sure the Fed can make it to their next meeting on January 31st without cutting rates. Look, all the swap spreads widened; all the corporate spreads widened; the Libor spreads widened. This is the credit clogging that Fed Vice Chair Donald Kohn talked about recently. But the Fed didn't act on it today. And that's the disappointment here, particularly with the discount rate.

The key point in the Fed statement is not the inflation reference. It's the repeated reference (three times) in a short statement of financial market strains. So what is so baffling to the market is having talked about financial strains, Bernanke & Co. didn't really act on it. It's a business as usual sort of thing.

But let’s look at the positive side. Who’s this new fella from Boston? This new Boston Fed President, Eric Rosengren? Hats off to him. He dissented. He wanted a 50-basis point shock and awe rate cut just like I did. Mr. Rosengren gets today’s medal of honor. I’m always looking for a silver lining.

Stocks may come roaring back over the next couple of days, because I think Goldilocks is still alive and well. But the Fed's statement today is baffling.

Tuesday Night's Special Fed Decision Lineup

On CNBC's Kudlow & Company at 7pm ET tonight:

***We are going to analyze and dissect today’s Fed decision and its implications for the economy, markets, Treasury man Paulson & the 2008 election.


*Jim Lacamp, portfolio manager at RBC Dain Rauscher
*Stefan Abrams, Bryden-Abrams Investment Management managing partner


*Alive Rivlin, former Federal Reserve Vice Chair
*William Ford, former Atlanta Fed President
*Steve Forbes, president and CEO of Forbes
*Art Laffer, economist & chairman of Laffer Associates


*John Browne, editor of
*Brian Wesbury, chief economist at First Trust Advisors
*Michelle Girard, senior economist at RBS Greenwich Capital
*Jerry Bowyer, chief economist at Benchmark Financial Network/NRO contributor

Please join us at 7pm ET on CNBC for another free market edition of Kudlow & Company.

Kudlow 101: Foreclosures & The Fed

The Fed is linked to foreclosures, and they can do something about it.

Take a look at the following homeowner distribution chart. It shows where all the mortgages are. It may surprise you to see who’s holding what kind of paper. (Hat tip to University of Michigan Professor Mark Perry and his fabulous blogsite, Carpe Diem. He put this together using Mortgage Bankers Association data.)

So, who’s got the mortgages?

Well, Prime Fixed comprises 41 percent. That’s the biggest share. Next up is Americans with no mortgages at all; they’re at 35 percent. And so on down the list. But I’d like to draw particular attention toward the bottom of the list, to the Subprime ARM group. They’ve got a 4.4 percent share. That’s obviously a very small percentage.

This next chart (also courtesy of Carpe Diem) shows you where the foreclosure problem resides. The following point is key: the smallest is the largest. In other words, the Subprime ARM is where the bulk of the foreclosures are.

In fact, the Subprime ARM group is responsible for 43 percent of foreclosures. But that group is a very small percentage of total mortgage holders. Moreover, the next group on the foreclosure list is the Prime ARM. They’ve got an 18.7 percent share. Add them together and over 60 percent of foreclosures are ARM related. In other words, it’s the skyrocketing of adjustable rates over the past couple years that’s the problem.

That’s the key point. It’s the adjustable rates—affected by the Fed—that’s caused the problem.

Okay, last chart. This shows the relationship between the fed funds rate and the subprime foreclosures. This is absolutely incredible.

You will notice that they are moving together. In fact, they start moving together in ’04. So there is a clear link between tight money from the Fed and the foreclosure rate.

The point of all this is to suggest that the Federal Reserve bears some of the blame for the huge increase in these adjustable rates. Frankly, very few people (and almost no economists) predicted rates would rise from 1 percent to 5.25 percent. So if the Fed truly wants to help people, they should get that funds rate down, so the pressure will come off adjustables.

Monday, December 10, 2007

Monday Night Lineup

On CNBC's Kudlow & Company at 7pm ET tonight:

RECESSION OR NOT?...The Dynamic Duo will duke it out. Former Clinton Labor Secretary Robert Reich and The Wall Street Journal's Steve Moore will go at it.

*Economist Bob Stein from First Trust Advisors will join in the debate.

THE MARKETS...Our market panel will discuss and debate all the latest news, trends, and developments affecting investors.

On board:

*Fritz Meyer, senior investment officer with A I M Advisors
*Mark Skousen, author and editor of Forecasts & Strategies
*Gary Shilling, president of A. Gary Shilling & Co.

Former FDIC chair Bill Seidman will join the market panel in a look at the housing market, the credit crunch and more.

DEBATE: TREASURY MAN PAULSON'S PLAN...On to debate are U.S. News & World Report's "Jimmy P" Pethokoukis and The Washington Post's Sebastian Mallaby.

THE DEATH TAX...The Dynamic Duo of Messrs. Reich & Moore will return in our final segment.

Please join us at 7pm ET on CNBC for another free market edition of Kudlow & Company.

Whoopi Trumps Oprah

Welcome to the supply-side Whoopi.

From today’s WSJ:

“…During a discussion of Republican Presidential candidates on ABC's "The View," which the comedian co-hosts, Ms. Goldberg said, "I'd like somebody to get rid of the death tax. That's what I want. I don't want to get taxed just because I died." The studio audience started applauding, but she wasn't done. "I just don't think it's right," she continued. "If I give something to my kid, I already paid the tax. Why should I have to pay it again because I died?"

… When another co-host, Joy Behar, responded to Ms. Goldberg's remarks by asserting, "Only people with a lot of money say that," Ms. Goldberg shot back, "No, I don't think so . . . It doesn't matter if you have or don't have money. Once you paid your taxes, it should be a done deal. You shouldn't have to pay twice."

Wow. You’re right on target. I had no idea. This is great news. Whoopi, you have an open invitation to join us on Kudlow & Company anytime…

Friday, December 07, 2007

Bush Boom Continues

There is no recession. Despite all the doom and gloom from the economic pessimistas, the resilient U.S economy continues moving ahead—quarter after quarter, year after year—defying dire forecasts and delivering positive growth. In fact, we are about to enter the seventh consecutive year of the Bush boom.

The pessimistas are a persistent bunch. In 2006, they were certain a recession was just around the corner. They were wrong. Instead, the economy posted two consecutive quarters of near or above four-percent growth.

Earlier today, a doom and gloom economic forecast from Macro Economic Advisors was released predicting zero percent growth in the fourth quarter. This report is off by at least two percentage points. These guys are going to wind up with egg on their faces.

Here are the facts: Americans are working. The 4.7 percent unemployment number remains at an historical low. On a three-month rolling basis, the U.S. economy has added over 100,000 jobs. Meanwhile, the household job count shows that an average of 303,000 jobs have been added in the last three months. This is noteworthy because it suggests that the job market is turning around.

Hours worked are growing more than 1-percent annually, while workers’ wages are running 3.8 percent, a full percentage point ahead of inflation. As for this week’s productivity report, it was nothing short of spectacular: the 6.3 percent productivity gain was the best in four years. A rise in productivity is good for growth. It’s good for profits. And it’s good for low inflation.

Speaking of inflation, business inflation is down from 3.5 percent just over a year ago to 1.5 percent today. Meanwhile, oil prices have retreated to $88. And, to top it all off, last night we received a tremendous new number showing household net wealth has headed even higher. It stands at a record $59 trillion dollars. That’s more than seven percent above a year ago.

Another factoid worth considering is that mortgage refinancings are soaring at lower rates. Since June, they are up nearly 70 percent, while mortgage rates on 15 and 30-year loans are down nearly a 100 basis points. That is a very positive, very welcome development that ought to cushion the plunge in home sales, and maybe even prices.

Down in Washington, Democrats are stuck with a Keynesian message of economic pessimism, spending increases, and tax hikes to finance their big government proposals. Unfortunately, they still refuse to acknowledge that tax rates have a profound effect on behavior. This kind of tax and spend, big government, Walter Mondale approach may come back to haunt them at the polls next year.

The GOP, on the other hand, has a positive supply-side message of limited government, lower spending, and lower tax rates. And while it’s true that the recent Republican-led Congress failed to adhere to its fiscal lodestars, the statute of limitations is quickly running out on that score.

Incidentally, Democrats have not offered a single spending cut proposal during their time at the helm. Not one. That’s just one reason why—not to mention what I expect to be continuing growth in 2008— I believe the economic pendulum will soon swing in favor of the GOP.

There’s no recession coming. The pessimistas were wrong. It’s not going to happen. At a bare minimum, we are looking at Goldilocks 2.0. (And that’s a minimum). Goldilocks is alive and well. The Bush boom is alive and well. It’s finishing up its sixth consecutive year with more to come. Yes, it’s still the greatest story never told.

Friday Night Lineup

On CNBC's Kudlow & Company at 7pm ET tonight:

THE MARKETS & THE ECONOMY...Our market panel will offer its insight on all the news and developments affecting investors.

On board:

*Mark Skousen, author and editor of Forecasts & Strategies
*Michael Panzner, trader/author of "Financial Armageddon"
*Jerry Bowyer, chief economist at Benchmark Financial Network/NRO contributor

MORTGAGES, MARKETS, & MORE...Tom Deutsch, deputy director of the American Securitization Forum will join us with his take. The market panel will also be aboard.

THE HUCKABEE INTERVIEW...The GOP presidential candidate and former Arkansas governor will join us for an exclusive one-on-one interview.

POLITICAL LANDSCAPE...Our political guests will discuss and debate all the latest political news and developments.

On board:

*Lanny Davis, former Special Counsel to President Clinton
*Terry Jeffrey, Human Events editor-at-large
*Richard Land, president of the Southern Baptist Convention's Ethics and Religious Liberty Commission

Please join us at 7pm ET on CNBC for another free market edition of Kudlow & Company.

Huckabee on Kudlow & Company Tonight

Republican presidential candidate and former Arkansas governor Mike Huckabee will be joining us for an exclusive interview on tonight's show.

We'll cover all the hot-button, Washington to Wall Street issues, as well as the Huckabee campaign's recent surge.

Incidentally, the AP/Ipsos poll out today has Governor Huckabee in second place in the GOP field, capturing 18 percent support from Republicans. Mr. Huckabee is on the heels of Rudy Giuliani who remains in first place with 26 percent.

CNBC. Kudlow & Company. 7pm ET.

Thursday, December 06, 2007

Kudlow 101: There Ain’t No Recession

Yesterday’s tremendous ADP jobs report puts the dagger into the very heart of the recession case.

The fact is, America is working.

Look at how close the reports parallel one another. So here’s my point: Jobs aren’t folding. Jobs aren’t plummeting. Jobs are strengthening. Now I’m not smart enough to know what the jobs number is going to be tomorrow, but you could easily have a blockbuster 200,000 jobs report. I don’t know, it could be 150K, it could be minus 600K, but I highly doubt that folks. When you see this kind of ADP report, you’ve got a whole new situation.

Now let’s move on to our second chart—productivity. The latest productivity report was staggering. In fact, it was the best in four years.

Productivity rising is good for growth. It’s good for profits. And it’s good for low inflation.

Look at our third chart—business inflation. Guess what folks? It’s falling.

Look at that. Down from 3.5 percent a year ago, to 1.5 percent today.

Finally, a look at financial profits.

After-tax, they are doing better than people think. We’re talking about 300,000 companies here, from the IRS based GDP reports. They are profitable. Sure, S&P financials are down about 35 percent. But NIPA financials are up 8 percent on the year.

So you’re looking at $332 billion of profits in the latest quarter, that’s a little less than last quarter. But it’s $20 billion more than the first quarter, $20 billion more than all of ’06, and about $60-70 billion more than ’05.

The point of the story is even if Wall Street takes $200-300 billion in mortgage losses, as a result of loan markdowns, profitability is more than adequate to stem the tide and hold us.

There ain’t no recession.

Sub-Prime Rescue Ups & Downs

The stock market verdict on the Bush/Paulson sub-prime borrowers’ rescue plan is thumbs up.

At the time of President Bush’s speech, the Dow was up about 65 points. As of this writing, it’s up 150. Financial stocks are leading the charge, up almost twice as much as the overall index. Homebuilder stocks are up huge, posting a 12 percent gain. Banks are also up, while the big brokers are up almost 3 percent. So investors so far are voting with their money in a positive way.

There are a lot of issues yet to be resolved about this plan, and I will be writing more about it tomorrow. In the meantime, some Wall Street analysts I spoke to believe this plan could do some small good. But it also possesses significant downside risks. Unfortunately, the history of these kinds of rescue efforts shows that borrowers on the verge of default/foreclosure may be saved temporarily, but they wind up defaulting and foreclosing anyway, over the longer run.

And since home prices are destined to fall much more in the next year — or two, or three — future foreclosures will come at much lower prices to be recouped with lower cash flows by investors holding sub-prime mortgage paper. Not good for the investors. Many analysts would have preferred a refinancing process that relied more heavily on existing government agencies such as FHA, Fannie Mae, and Freddie Mac.

All that said, in political terms, President Bush and Treasury man Paulson had to do something.

The pure, free-market option that may make the most economic sense — letting markets adjust along with the winners and losers — is just not an option in this intensely political season. In this environment, the president chose the least worst option, one that has no direct bailouts using federal budget money (which of course is taxpayer money). Senator Hillary Clinton would put up a quick $5 billion and maybe as much as $7 billion, whereas Mr. Paulson is avoiding that expenditure.

If the economy stays afloat (which I still believe is the likeliest outcome) then perhaps the interest-rate freeze will buy some time for the working poor to refinance. It’s a big maybe.

More to come . . .

Thursday Night Lineup

On CNBC's Kudlow & Company at 7pm ET tonight:

THE MORTGAGE RESCUE PLAN...Our guests will discuss and debate the Bush administration's plan to aid certain homeowners who face the prospect of higher mortgage rates in the next few years.

On board:

*Robert Shiller, housing expert/Yale University econ professor
*Joe Battipaglia, Stifel Nicolas market strategist
*Steve Moore, member of the Wall Street Journal editorial board
*Art Laffer, economist, chairman of Laffer Associates

Also on board for one-on-one interviews:

*U.S. Housing and Urban Development Secretary Alphonso Jackson
*Rep. Barney Frank (D-MA), Chairman of the House Financial Services Committee

THE SUBPRIME PLAN: ARE LAWSUITS AHEAD?...On to discuss what may become a class action tort lawyer's dream come true, and whether we're busting private contracts, are the following guests.

*Mark Lanier, mass tort lawyer and founder of The Lanier Law Firm
*Nicole Deese, securities attorney at Fowler, White & Boggs

The market panel will weigh in with their thoughts on the subject.

THE ROMNEY SPEECH...On to discuss today's speech by the GOP presidential contender and the role of religion in politics are the following guests.

*Walter Russell Mead, Henry A. Kissinger Senior Fellow for U.S. Foreign Policy at the Council on Foreign Relations
*Jay Sekulow, chief counsel of the American Center for Law and Justice
*Ralph Reed, social conservative

Please join us at 7pm ET for another free market edition of CNBC's Kudlow & Company.

Wednesday, December 05, 2007

The Recession Debate Is Over

There ain’t no recession.

Today’s ADP private jobs survey of 189,000 could produce a 200,000 non-farm payroll job gain for November. I don’t know — these wacky BLS numbers are subject to huge revisions. But the ADP was a huge number. In fact, jobs seem to be picking up major steam from their August low, rising in September and October. And now I’m expecting a good increase in November to be reported by the BLS this Friday.

Plus, profits are stronger than people seem to understand. The ISMs are fine. Productivity, reported out today, soared to over 6 percent annually in the third quarter. That’s the best productivity number in four years for output per person.

On top of that, business inflation is zero. Flat. Nada.

The recession debate is over. It’s not gonna happen. Time to move on.

At a bare minimum, we are looking at Goldilocks 2.0. (And that’s a minimum). The Bush boom is alive and well. It’s finishing up its sixth splendid year with many more years to come.

Wednesday Night Lineup

On CNBC's Kudlow & Company at 7pm ET tonight:

THE MARKETS...Our market panel will discuss and debate all the latest issues, news, and developments affecting investors.

On board:

*Brian Wesbury, chief economist at First Trust Advisors
*Bill Greiner, chief investment officer at UMB Asset Management
*Jim Lacamp, portfolio manager at RBC Dain Rauscher
*Michael Ozanian, Forbes Magazine Senior Editor

CAPITAL MARKET COMPETITIVENESS...Hal Scott, securities-law expert at Harvard Law School and director of the Committee on Capital Markets Regulation will join the market panel in this discussion.

YOUR MONEY, YOUR VOTE...On to debate what's ahead in the 2008 presidential race and much more are former Republican House Majority Leader Dick Armey and Gary Gensler, former Treasury Undersecretary.

A LOOK AT HOUSING...We'll have a one-on-one interview with Sheila Bair, chairwoman of the Federal Deposit Insurance Corp (FDIC).

Please join us at 7pm ET on CNBC for another free market edition of Kudlow & Company.

Ben Stein Takes on Goldman Sachs

The following transcript is from last night's Kudlow & Company.

KUDLOW: On this evening’s program, famed economist and author Ben Stein has very harsh words for Goldman Sachs in his latest column, comparing their subprime short selling of securities sold to customers with the tech research scandals five years ago. Mr. Stein also questions whether former Goldman Sachs CEO Henry Paulson, who is now Treasury man, should in fact, be Treasury Secretary.

And Senator Chris Dodd, Banking Committee chairman just a few moments ago, called for a formal investigation about Ben Stein’s criticism of Henry Paulson. Here’s what Senator Dodd had to say:

“I am deeply concerned about the questions raised by Mr. Stein’s story in the New York Times yesterday about the activity of Goldman Sachs in aggressively pushing sub-prime mortgages that they knew to be of concern while simultaneously shorting collateralized mortgage obligations. If these facts are indeed true, the administration’s inaction when this crisis began to emerge earlier this year, is increasingly suspect. It is in the best interest of resolving this crisis if Secretary Paulson, who was leading Goldman at the time in question, addresses the concerns raised by Mr. Stein’s article. Failure to do so may be cause for a more formal investigation.”

The Treasury Department meanwhile, responded to our inquiry about Mr. Dodd’s statement and they said, “The Secretary is working with members of both parties to develop solutions for struggling homeowners. This is where all of us need to focus our attention.”

Ben Stein joins us now. So Ben, you have stirred up quite a hornet’s nest. Let me begin with the idea that Goldman Sachs was in fact short selling subprime mortgages, collateralized debt obligations, that they sold to their customers in huge bulk. Tell us about that.

BEN STEIN: Well, wait a second. First of all, all the credit over this goes to Alan Sloan who did a brilliant piece on this whole subject for Fortune. And it was that that cued my whole interest in the subject. His piece is just brilliant journalism. But apparently, if I am to understand said Mr. Sloan right, and a further raft of comments by Goldman Sachs spokesmen further, they were selling the collateralized mortgage obligations [while] simultaneously selling short either the same obligations or an index based on the same kind of obligations. That went into high gear in 2007 as they were still selling CMOs. They were also selling, and on a big scale, indexes against those CMOs. So they were on the one hand pushing the product and on the other hand, to me, seemingly indicating that they did not have confidence in the product, by shorting either the product, or a similar basket of securities.

KUDLOW: Now Ben, some would say that this kind of shorting of securities sold out, they packaged them and sold them, essentially represents a prudent hedging strategy to defend shareholders’ capital. Your thought on prudent hedging strategies?

STEIN: Well there are two things. One, I think that’s what’s known as the green shoe operation. And it’s a fairly well known thing. I don’t consider it ethical frankly. I don’t consider it ethical to on the one hand, tell your people to whom you owe a fiduciary duty, we’ve got a product for you and we stand behind it, and at the same time, short it. I question whether that is an ethical thing to do. And I think the people to whom they owe a fiduciary duty, in the way of pension funds, nurses unions, those people, stand ahead of the stockholders in terms of fiduciary duty. That’s one thing.

Second thing is as I understand the comments by the Goldman Sachs spokesman correctly, and I may not, they shifted those short sales into very high gear in 2007, maybe even earlier, way beyond what prudent, normal hedging would be in an underwriting operation. So I think we’ve got to find out more about it. But from what I understand their operations were on both sides of the deal. And that is not, it seems to me, cricket.

But now people keep emailing me, I’ve gotten hundreds of emails about this, people keep saying, well that’s the way it’s done on Wall Street. And I say maybe so, that doesn’t make it ethical. I mean, there are a lot of things that are done that are not ethical. And I question whether a guy who was presiding over the firm that does this kind of thing, is the right kind of guy to be Secretary of the Treasury at this particular juncture.

KUDLOW: Mr. Paulson in fact, Mr. Paulson?

STEIN: Right. Now I am positive that he is a fine man. I know that he is a big environmentalist and I know he is a fine man in many regards. And maybe he just thinks he was doing what’s always done on Wall Street. I don’t think business as usual on Wall Street is the right way to be doing business right now. It was business as usual on Wall Street that got us into this housing mortgage problem. It seems to be business as usual has got to change, where they’re not pushing this stuff out the door with one hand to unsuspecting buyers and selling it short with the other hand. If they were doing that, it seems to me that’s an ethical issue and it’s got to change.

KUDLOW: Now you are comparing this taking short positions at the same time that they’re, to use your phrase, pushing subprime mortgage related securities out the door to customers, you are comparing this to the Henry Blodget et al research scandal, technology research scandal, conjuring up some names that we’d probably prefer to forget in the earlier parts of this decade. Jack Grubman being another, Mary Meeker being a third. All of that was of course prosecuted by then New York Attorney General Elliot Spitzer. Ben Stein, are you suggesting that this is a Spitzer moment now—Andrew Cuomo is the new AG—and that there ought to be investigations first of Goldman Sachs? Is that what you are suggesting? You want to investigate Goldman?

STEIN: Well I think the whole business of Wall Street in this regard, of CMOs, needs to be investigated. I think how much they knew about how dangerous this product was, how aware they were of the dangers in the housing market as they were selling this to fiduciary institutions, I think that needs to be investigated. Because it’s bad enough that they were just selling stuff that they knew to be extremely dangerous to innocent buyers. If they knew it, and also were shorting it, that’s even worse. Now if I have misunderstood this, and it’s very possible that I have, I’m just a person and I make mistakes like everyone else, then its fine. But I think some investigation is warranted.

KUDLOW: Now again, I don’t have any skin in this game. And I agree with you, I think Henry Paulson is a fine, fine person. I think he’s done a very good job as Treasury secretary.

STEIN: Well there I must say we part ways.

KUDLOW: Alright, well I think he’s giving it his best shot in a very difficult period.

STEIN: Well I don’t doubt that he’s giving it his best shot. But that’s not the same as doing a very good job at it.

KUDLOW: Alright, well, I gave him an eight out of ten last night on the program. And I will continue that rating until proven otherwise.

STEIN: Well you’re a good friend. You’re a good friend.

KUDLOW: But I want to go back to the beginning of your column. Goldman’s top economist Jan Hatzius…issued a very, very, very pessimistic report hinting at recession. You didn’t much care for the report. You call his document selling fear.

STEIN: Well I think it is.

KUDLOW: And as I understand it, what you’re doing here, you’re connecting dots: [You’re suggesting that] Hatzius is selling fear in the sort of reverse way that Blodgett and others tried to sell tech securities. He’s selling fear, which then might knock the prices down of the very subprime CDO securities that Goldman Sachs is short selling. So you see this all of a piece and you don’t much like it. Is that right?

STEIN: Well that’s my hypothesis. I could be totally wrong. I mean, Mr. Hatzius I’m sure is also a fine man and a very fine economist. But that is my hypothesis that maybe that what’s happening. These guys are business economists. They’re not Milton Friedman. They’re not Anna Jacobson Schwartz. They’ve got some skin in the game. It’s natural for an economist to please the person who signs your paychecks. I’m not saying he’s a bad person. I’m sure he’s a very fine person. But it’s natural to want to please the people who are your friends and who are paying you.

KUDLOW: You know many years ago Ben, I served as the chief economist of Bear Stearns and Company on Wall Street. And I was there on two separate occasions, actually was a senior partner twice, I may still be the only guy to have achieved that, went to Washington, came back to Bear. But here’s my basic point. All the years I had that position nobody in the top brass, the top offices, the top executive suites, ever put any pressure on me to put out a forecasting or research report either to match longs or shorts or whatever. In fact Ben, I must say with all due humility, the top notch traders at Bear Stearns, they traded on whatever they traded. Maybe they listened or read my reports, maybe they listened to my view or not, but they really did not ever depend on the scribblings of an economist. And I just can’t help wondering if you’re not overestimating Mr. Hatzius’s influence inside Goldman Sachs.

STEIN: Well maybe I am. It’s entirely possible. I make a great many mistakes. But I’ll tell you what. He’s been bearish on housing for a long, long time. If he was that bearish on housing, why is his firm underwriting so much housing based security issues? If he thinks it’s a catastrophe waiting to happen, why is his firm underwriting tens of billions of dollars in an area that’s headed for catastrophe?…He’s been being negative on it for a great many years and they’re still selling into that market that he’s negative about. If I may say so Larry, with the greatest possible respect, if you are a business economist, and you’re issuing a forecast that you know to be different and contrary to the interests of your traders, you’re a very brave man indeed and my hat’s off to you.

KUDLOW: Well again, I’ll just say that when I held that position at Bear Stearns years ago, nobody ever interfered. That’s my only point. I actually didn’t know whether the traders in the many risk taking desks were long or short or whatever. I just tried to give it my best shot. Like all other human beings, sometimes I got it right, sometimes I got it wrong.

Tuesday, December 04, 2007

Twenty-Five Years of Prosperity (and more to come)

A significant paradigm shift has taken place in the U.S. economy over the last quarter century. During that time, the U.S. economy has been in prosperity 95 percent of the time and in recession only 5 percent. That is, the United States has had a grand total of only five negative GDP quarters in the past 25 years. In the prior two decades, the U.S. economy was mired in recession about a third of the time. This earlier period was a time marked by high inflation, high taxes, and overregulation of the economy. This caused the U.S. to look weak, while the Soviet Union looked strong. Clearly, things have changed. Prosperity has become the rule, not the exception.

Three fundamental reasons point to the cause of this long-lived prosperity:

Global Spread of Capitalism

Across the globe, free market capitalism has been triumphant over the socialist-planning model. Karl Marx was wrong; Milton Friedman was right. Put another way, the central planning model did not work whereas the free market model did. Fortunately, two strong, visionary, broad-shouldered leaders were in power while historical forces were aligning to push markets in the free-market capitalist direction. One of them, of course, was Ronald Reagan. The other was Margaret Thatcher.

Over the past two and a half decades, the capitalist model has spread like wildfire around the world, and it shows no sign of pulling back. In China, India, Eastern Europe, and Russia, however imperfectly, the newfound principles of free-market capitalism, economic opportunity, and “liberalism” in the traditional sense of that word are being applied and working beautifully. In one country after another, hundreds of millions of people are climbing out from the pit of poverty. Middle classes are growing by leaps and bounds. This will continue for many years to come.

Our world has witnessed a total shift in the intellectual thought of economics. That shift has created more growth, prosperity, income, wealth, and business opportunity than anybody dreamed imaginable—including me.

As an indication of how remarkable these changes are, the Chinese congress recently did a couple of things worth thinking about. First, earlier this year, the congress took a further step away from its communist past by passing legislation that strengthened private property rights for individuals and businesses. Second, a serious, vocal, intense debate among Chinese intellectuals is taking place concerning the merits of instituting major democratizing reforms. At the federal level, this does not mean that pure democracy will be breaking out any time soon. But at the local level, voting is occurring for the first time. It is not possible to overstate the magnitude of the dramatic changes that have occurred in China over a comparatively brief time.

Low Income Tax Rate Regime

As a supply-sider, I believe that a low income tax rate regime possesses tremendous power to change economic behavior. Economic freedom dictates that people should keep more of what they earn after tax. Recent Nobel Prize winner Edward C. Prescott from the Federal Reserve Bank of Minneapolis and Arizona State University put it quite clearly and succinctly when he said that economic behavior responds significantly to changing tax rates. In addition, the economic power of lower marginal tax rates on capital gains and dividends is similarly huge. The low tax rate regime of George W. Bush’s administration has given a big boost to the overall economy and the investment sector.

Behavior of Central Bankers

Central bankers have come to hate inflation. This is a key point. The cruelest tax of all is inflation. It distorts everything. It reduces the value of everyone's money and buying power. It lowers rewards for risk-taking and returns on investment. It impedes investment and expansion. Moreover, most tax systems are not even indexed for inflation.

Thirty years ago, central bankers had developed an unfortunate tolerance for inflation. They believed it was the trade-off for lower unemployment (the Phillips curve). That tolerance led directly to the double-digit rates of inflation that the United States experienced in the late 1970s and early 1980s. But since the time of Paul Volcker, central bankers have developed an almost obsessive vigilance combating inflation. That vigilance has helped pave the path for more than 25 years of tremendous prosperity.

* * *

These three points are key parts of what I refer to as the greatest story never told. It is a story of optimism. It is a story of wealth creation. It is a story of economic growth and prosperity. In the end, it is ultimately a story of great hope and great promise.

Tuesday Night Lineup

On CNBC's Kudlow & Company at 7pm ET tonight:

INTERVIEW WITH BEN STEIN...The economist, actor, and lawyer will discuss his recent New York Times op-ed criticizing Goldman Sachs, what's ahead for the stock market and economy, and more.

THE MARKETS...Our market mavens will offer their perspective on all the trends and developments affecting investors.

On board:

*Jeff Kleintop, LPL Financial chief market strategist
*Michael Metz, chief investment strategist at Oppenheimer & Co.
*Dennis Kneale, CNBC media and technology editor

WHAT'S GOING ON IN IRAN?...An exclusive interview with Senator Joe Lieberman (I-CT).

THE ECONOMIC LEGACY OF PRESIDENT BUSH...Joining us to discuss will be Nobel-prize winning former World Bank economist Joseph Stiglitz.

Please join us at 7pm ET on CNBC for another free market edition of Kudlow & Company.

Kudlow 101 Replay - The U.S. is a Winner

Last week on Kudlow & Company, we spent some time discussing news that some big state pension funds (Texas, California, and New York) are moving out of U.S. stocks and into foreign equities. In some cases, they're dropping their U.S. exposure to as low as 25 percent.

I'm not sure that's such a good idea, when viewed in light of the long-term success of the U.S. stock market. In fact, since the early 1980s the Dow’s up roughly 1200 percent, including dividends. That’s a 14 percent annual rate of return.

Here's the clip: