By Lawrence Kudlow
TEMPERING THE TERMINATOR
There's more to making money, Alan.
July 23, 2001 8:35 a.m.
Alan Greenspan went through his Terminator III act last week, pledging to
the Congress and the nation that he and the Federal Reserve will do all that
it takes to finance economic recovery. Of course, the heavyweight central
banker has already reneged on his earlier forecast that recovery would come
in the second half. It's now July, which begins the second half, and there
is no recovery.
And, in a rare moment of candor, he told the House Financial Services
Committee that the U.S. economy is "not out of the woods yet." So the great
monetary leader left the door wide open for additional easing moves.
During his testimony Greenspan was especially proud of Fed efforts to
reignite money-supply growth as a pro-recovery measure. This is a good
thing, because it was the Fed's massive deflation of money last year that
completely leveled the stock markets and put us in the fix we are in today.
The trouble with all this macho money-creation is that you can lead a horse
to water but you can't make him drink. While the Fed is beginning to pump
more high-powered cash into the economy, a public that is still reeling from
the after-effects of stock-market shock refuses to put any of that money to
productive use in the economy. Investors recoiling from a vicious 70% NASDAQ
drop, and an even worse total wipe out of the dot-coms, are not yet willing
to take any economic risks. As a result, things like venture-capital funds
and initial public offerings - the capital-investment seed corn that funds
the most innovative and risky new enterprises necessary to move the country
to the next level of technology-driven prosperity - aren't being financed.
Nobody, it seems, wants to commit the first new dollar. This is what John
Maynard Keynes meant when he talked about sagging animal spirits in the
So where's all the Fed's new cash going? Money-market funds, where savers
get a risk-free, guaranteed return.
Year to date, retail and institutional money funds are rising at an
eye-popping 38% annual rate, or just about $50 billion a month. This is more
than twice last year's pace. Trouble is, this sort of investment is
basically for little old ladies in tennis shoes. It's not the aggressive,
high-tech, entrepreneurial risk taking that will fund the next great idea,
the one that could transform the economy and increase productivity. Until
this moss-covered, risk-averse psychology changes, the Fed can drop interest
rates to zero and dump cash into the economy by the wheelbarrow. But the
economy will not improve.
So how might government policy makers turn this story around? If they
provided new tax-cut incentives for investment, they might just unlock
risk-taking spirits and get the Fed's money working productively in the
economy. The odd part about Bush's tax-cut plan is that the expected flood
of rebates this year is designed to stimulate consumer spending; the
investment incentive-effects from lower tax rates don't kick in for another
4-5 years. But consumer spending isn't the problem. In fact, that's the only
area keeping us out of recession. It's the collapse of business-investment
spending that has been the principal economic illness - especially
technology-related investments which have completely dried up.
Policy makers should be focused on the supply side of the economy, not the
demand side. "Clever use of further tax cuts - this time to encourage
capital spending - may help prevent those widespread job cuts that would
ultimately guarantee a recession," writes Brian Nottage of The Dismal
Scientist. Nottage recommends accelerated depreciation allowances that would
permit a quick write-off for companies investing in new equipment.
This is exactly what former Reagan Treasury advisor Steve Entin supports.
Mr. Entin is backing the High Productivity Investment Act, a bi-partisan
bill crafted by Reps. Phillip English (R., Pa.), and Richard Neal (D.,
Mass.). This measure would let businesses claim the full cost of their
investment in high-tech equipment as a business expense in the year it was
purchased, and would also shorten the time period for all other equipment
purchases. According to Entin, faster write-offs would "lower the cost of
utilizing equipment and increase capital formation, resulting in higher
labor productivity, real wages, and employment."
Another tax-cut measure that would surely reawaken investment spirits would
be a reduction in the tax rate on capital gains. "An increase in the
after-tax return of investing in securities also implies a decrease in the
expected profits investors require from currently hurting companies," writes
the dismal scientist, Mr. Nottage.
The self-financing capital-gains tax cut in the mid-1990s provided a booster
rocket to stock markets and economic growth.
Investment tax cuts would encourage savers to take new risks and would put
Fed money creation to real work. Whenever after-tax rewards are sweetened,
more investment is sure to follow. With energy costs coming down, along with
lower inflation and interest rates, the sickly economy will surely mend over
time. But the question is how quickly and at what pace will this economic
A new round of investment tax cuts will give Terminator III Greenspan some