Measures Against Malaise
How to keep the good times rolling.

By Steve Forbes, editor in chief of Forbes magazine
April 16, 2001 Issue

growing number of observers say that we're in for a prolonged period of tough economic sledding: The NASDAQ has wiped away $4 trillion of wealth, and the rest of the stock market is being hammered as well; consumers and corporations are up to their eyeballs in debt; the rest of the world looks blah or even bleak. We went on a binge — dot-coms, this time — and now we are suffering the inevitable, head-splitting hangover.

Hogwash. The doomsters will be right only if we make major policy errors. If the correct steps are taken, we should see the markets rebounding by fall, and the economy expanding smartly by the turn of the year.

The principal villain at fault for these storm clouds is the Federal Reserve. From the summer of 1997 to the summer of 1999, the Fed inadvertently embarked on a deflationary course. Not enough dollars were being created to meet demand in the marketplace. The Fed apparently forgot that the dollar is now an international currency; over two-thirds of our printed greenbacks end up being used offshore. The Fed blunder initially hurt the rest of the world more than it did us — that deflation was an unindicted co-conspirator in Asia's crisis of 1997–98 and in Latin America's of 1998–99 — but American farmers began to feel the impact 18 months ago. Then the Fed went further, deliberately deciding to squeeze the economy by ratcheting up rates, because of a mistaken and deadly belief that prosperity causes inflation.

Fed economists confuse price changes that are a result of routine supply-and-demand pressures with price changes that are a result of a debasement of the currency. The oil spikes of the 1970s did not occur because of a sudden surge in demand; inflation was the cause. Conversely, the 1997 jump in the price of some commodities was not related to the money supply, but to the fact that capacity was not keeping up, for a while, with demand.

Greenspan & Co. were also working themselves into a lather over the booming equities market. Greenspan's now-infamous "irrational exuberance" speech in 1996 was given when the Dow was around 6,400. The Fed does not have a mandate to guide the stock market, but Greenspan felt we were in danger of a bubble similar to the one the Japanese had experienced in the 1980s. For a long time, he was oblivious to the real and extraordinary technological breakthroughs being developed. The Fed has done to our economy, in a milder way, what the Bank of Japan's stringent monetary policy did to Japan's: starved it of sufficient credit.

Greenspan's recent rate cuts are not working, because the Fed still isn't creating enough credit to alleviate the economy's dehydration. It's like going to a gas station and finding that the price of fuel is lower, but the gas station won't sell you more than a gallon of gas at a time, and even that only once a month. You are still not going to drive very far, very fast.

After a decade, the Bank of Japan is finally reversing course and will start pumping yen into Japan's parched economy. The Fed should follow suit here. Forget about pegging interest rates; just give us enough fuel to get the American economy humming again. (A good gauge is the price of that much-maligned metal, gold. When it gets up to the $300–$325 level, breathe easier; the Fed is truly easing up.)

Another culprit is taxes. The political culture can never seem to accept this simple but basic truth: Taxes are a burden and a price. The taxes people pay on income, profits, and capital gains are the price they pay for working, for being successful, for being willing to take risks. America's very prosperity has pushed people into higher tax brackets, punishing and burdening them and decreasing their incentive to engage in further productivity. Moreover, millions of taxpayers are ruefully discovering that various deductions and tax credits are phased out when they exceed certain income levels. Millions are also getting hit with the Alternative Minimum Tax, designed 30 years ago to catch tax-dodging millionaires, but now crushing more and more middle-income taxpayers. Millions of Americans now run their businesses as sub-chapter S corporations, which means that their business income is taxed as personal income.

Other causes of the slowdown are excessive regulation — as the high-tech sector gets caught in the molasses-like regulatory structures afflicting the telephone, TV, radio, and cable industries — and an out-of-control plaintiff bar, which is now enacting taxation through litigation, starting with tobacco.

The immediate course of action is clear: If we ease money aggressively, cut taxes even more than President Bush has proposed, and make the tax cuts effective more quickly, the economy will pick itself up in no time. President Bush should beef up his tax package in the following specific ways: cutting the capital-gains tax to 10 percent, abolishing the Alternative Minimum Tax, letting people contribute more to their Roth IRAs and their 401(k)s, permitting mutual-fund shareholders to defer capital-gains taxes until they actually sell their shares, removing the 3 percent Spanish–American War telephone tax, and extending the Internet tax moratorium.

No matter what we do, of course, hundreds of those dot-coms won't be resurrected. But the shareholders' pain over these failures need not result in any serious long-term harm to the economy. The doomsayers should remember that the booming 1980s — which actually had growth rates exceeding those of the 1990s — had major busts in energy and agriculture. Texas, Iowa, and other parts of the country were economic wastelands—but America, as a whole, prospered.

A lot of those dot-coms were flaky and will forever be featured in the chronicles of bubble historians. But their technology is awesomely real, and so-called Old Economy companies have used it to increase productivity enormously. General Electric alone will spend $16 billion online for procurement this year; the Internet is rapidly subsuming telephones, television, and radio; and Napster is a wake-up call to the music industry about its traditional distribution methods.

Players in any new technology often fall by the wayside. America's corporate graveyard has hundreds of headstones of automobile manufacturers. Remember when personal computers hit the scene in the 1980s? Atari, Commodore, and Texas Instruments ended up taking a huge hit. But the P.C. revolution — as Wang, Digital Equipment, and IBM (which nearly went broke in 1992) could testify — was genuine.

We have had spectacular stock-market drops before, without setting off another Great Depression. In the spring of 1962, equities experienced the severest one-day drop since the crash of 1929. But thanks to President Kennedy's sweeping across-the-board tax cuts (several times greater than those President Bush is proposing), a less antibusiness attitude in the White House, and a sensible Federal Reserve, the economy continued to grow with increasing "vigah." The 1987 crash, similarly, did not presage a depression.

Jeremiahs like to point accusatory fingers at the enormous growth of personal and corporate indebtedness, and the S&P 500's above-average price-earnings ratio. Some of that debt came from technology companies buying up their own stock and reissuing it in lieu of cash to their employees: In a healthy economy, that's a healthy thing to do. Many Americans are indeed over their heads in debt, but most — absent a bone-cracking recession — are not. The American people, moreover, have — in general — a remarkable ability to rebuild their balance sheets when they sense things are not going well. If sensible policies are pursued, their purse strings will loosen. Furthermore, price/earnings ratios have been trending upward for a century. With the Cold War won, inflation subdued, and a fantastic era of innovation unfolding, why shouldn't p/e ratios continue to improve?

Making the right choices now will make a huge difference for our economic future. The Great Depression was a worldwide disaster, and it was ushered in by the Smoot-Hawley Tariff — which destroyed world trade and the flow of capital. Herbert Hoover's incredibly poorly timed tax increase — which kicked in in 1932 — exacerbated a bad situation; and Fed policy was — then as now — absolutely unconstructive.

Similarly, the miserable stagflation economy of the 1970s came about because of bad policy choices: The great inflation was unleashed by the destruction of the Bretton Woods gold-based monetary system, combined with the catastrophic tax increases that resulted when inflation pushed people into higher tax brackets. (This, by the way, was precisely why Ronald Reagan indexed the personal tax code to inflation; he wanted to prevent such unlegislated tax increases.) The doom and gloom of those malaise-ridden years seemed permanent — but when Reagan reversed those catastrophic errors, the American economy rapidly turned around.

If President Bush — both in public and behind the scenes — pushes the right policies, genuinely muscular and bold prescriptions for economic growth, the unpleasantness we are now experiencing will become a historical footnote. If he does not…