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Subject:KUDLOW'S TAKE -- National Review Online Financial -- September 7,
Date:Fri, 7 Sep 2001 07:12:23 -0700 (PDT)

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by Lawrence Kudlow

Washington needs to come to its senses.

Economic recovery is just around the corner, if you're to believe leading
officials at the Federal Reserve, the Treasury, and the White House. By
"recovery" they mean a 3% growth rate next year, with high expectations that
clear rebound evidence will surface during this year's fourth quarter. But
judging by the continued stock-market plunge, the public is not buying what
the government is selling.

This has been one of the worst summer stock markets in recent history. The
much-heralded summer rally never materialized. In fact, despite repeat Fed
rate cuts and a federal consumer tax rebate, the technology-driven Nasdaq
has lost another 25% of its value in the past three months, with the broader
S&P 500 index dropping 15%.

Traditionally, stock markets are a leading indicator of the economy. When
markets began hemorrhaging last summer and fall, they correctly signalled
the onset of a business slump. This has happened many times in economic
history. Going back 20 years, during the early Reagan administration,
national economic gloom was punctured by a big stock-market rally in the
second half of 1982 which correctly heralded the long prosperity boom.

But it's not happening now. Actually, applying a normal six-to-nine-month
lead time, stock markets are beginning to signal that no recovery will occur
until the second half of next year.

Investor spirits and business confidence continues to sink. A daily drum
beat of bad earnings reports has overwhelmed the stock markets. Some of the
numbers are startling: semiconductor profits are off 85%; telecommunications
are down 72%; durable-goods are makers off 77% - all for the second quarter.
Leading surveys now predict an incredible 67% additional drop in technology
profits for the third quarter, and perhaps another 40% drop in the fourth.

The real message coming from the equity market is that the economy is
getting worse, not better. Undoubtedly, some of this pessimism springs from
a rather looney-tune debate in Washington, where leading Democrats are
ranting over dwindling budget surpluses, virtually foreclosing any hope of
additional and much-needed tax-cut stimulus. Al Gore's old lockbox for
Social Security trust funds has resurfaced. And the Bush administration,
which is favorably inclined toward business tax cuts, increasingly finds
itself boxed in by Social Security scare tactics.

But there are signs of sanity in Washington. Dan L. Crippen, the head of the
Congressional Budget Office, testified that "the attention given to what's
in the Social Security trust fund come 2015, or even if the trust fund
exists at that point, is misplaced," adding that "the payroll taxes will
have no changes due to the president's tax cut." Then, in the most sensible
statement to come out of Congress on this debate, Crippen noted, "What will
matter is the size of the economy."

Bravo. Crippen for president, or Fed chairman, or something. The size of the
economy and its ability to grow is the absolute keypoint that is being
ignored in this dreary, Herbert Hoover-like budget debate.

While the Bush tax cuts passed by Congress are a move in the right direction
over the long term, in the short run they are having little or no effect.
Retailers around the country are reporting virtually no evidence that the
tax rebates are boosting sales. Even more to the point, the nation is faced
with a supply-side business downturn, not a consumer demand-side decline.
It's as though the government economic doctors, having made the wrong
diagnoses, are now prescribing the wrong remedy.

On the monetary side, the Fed is finally ending its scorched-earth deflation
by cutting interest rates and expanding the money supply, which will propel
aggregate demand, not supply. Yet, the collapse of business investment,
production, and profits is a supply-side, or investment-side, problem. The
right remedy would be across-the-board tax reform to boost work effort and
capital formation through lower tax-rate incentives on individuals and

But the tax-rate reduction in the Bush plan doesn't kick in for five years.
And with Democrats ranting over the holy budget surplus, the chance of true
business tax relief - including measures such as capital gains and
accelerated depreciation allowances - are minimal.

The Fed, the White House, and the Treasury should heed the message of the
real-world stock market. It is clearly telling us that the economy could be
much worse, and that the role of government policy should be much more
stimulative on both money and taxes. A combination of supply-side tax cuts
and greater Fed stimulus will grow the economy, protect Social Security,
increase long-term budget surpluses, and preserve America's role as world

The sooner Washington comes to its senses the faster economic recovery will